Economist
November 9, 2011
Paul Krugman points us to Nouriel Roubini who argues that the history of internal devaluations—that is, restoring competitiveness through wage declines rather than exchange rate shifts—is mostly a history of failure. Reading this, it is difficult to be optimistic about Greece or Portugal: the way ahead probably paved with unemployment and economic decline. What's more, the political will to go through such a period in order to stay in the euro, retain the high connectedness to Europe and finally regain strength and grow, is of crucial importance. The Baltic states (Estonia, Latvia, Lithuania) probably have more of that than Portugal or Greece, and may have (as Ireland has) a flexible enough economy to get it over with quickly.
One should be careful with comparisons of countries, though. Small countries like Ireland or Latvia may not have benefited from a potential external devaluation as much as is commonly assumed. Iceland is a case in point (yes, once again). It made use of external devaluation, but it actually had to impose capital controls to limit the adjustment. What followed in a country that imports almost everything except fish and hot water is a temporary surge in inflation. Its real GDP performance, however, is very similar to that of Ireland or the Baltics; after adjusting by PPP, the real expenditures per person have fallen considerably and are still in decline (see chart, HT Jon Danielsson).
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