AN ECONOMIC crash in Finland in the early 1990s that has similarities with Ireland’s current crisis was only resolved with a 40 per cent devaluation of its currency, a measure that is not available here, a conference at the Economic and Social Research Institute is to hear today.
In the absence of devaluation, the only option appears to be deflation, but the adjustment is likely to be painful and slow, the conference will be told.
Credit expansion fuelled an investment boom and an asset price bubble in Finland in the 1987 to 1990 period, Jaakko Kiander of the Helsinki Labour Institute for Economic Reform will tell the conference. In the latter half of the 1980s Finland experienced rapid growth in output, consumption and investment. It had full employment and low public debt.
However, the international economy then slowed and the collapse of the Soviet Union led to a 10 per cent drop in Finnish exports. The exchange rate of the Finnish markka came under pressure and the Finnish central bank increased interest rates.
To avoid devaluation, it was decided to depress demand and cut wages, an “internal devaluation”.
Private investment slumped by half in the three years to 1993. Private consumption fell by 10 per cent, stock market prices collapsed by 70 per cent and house prices fell by 50 per cent.
Mainly as a result of collapsing domestic demand (minus 20 per cent), gross domestic product (GDP) fell by 13 per cent from mid- 1990 to mid-1993. However, exports began to recover by 1992.
Banks, firms and indebted households all sought to reduce their debts, creating a collapse in aggregate demand. Social benefits were frozen or reduced.
Unemployment rose to 18 per cent in 1994, creating permanent increases in long-term unemployment and poverty.
Public debt surged from 12 per cent of GDP to 60 per cent over the five years to 1995. Income taxes and employers contributions were increased.
The consequences of the deflationary policies that were pursued were not understood by the policymakers, Mr Kiander will tell the conference, nor were the macro-economic consequences of falling asset prices.
As a result, policy makers were surprised by the depth of the crisis.
