Relative Price Level Developments in the Baltic Economies and Lessons to Learn from the Crises

Abstract

Estonia and other Baltic countries experienced speculative boom in years 2004-2008. The boom resulted in rapidly rising relative price level or real exchange rate. Euro wages are used as proxies for bilateral real exchange rates. Rapid reversal of capital inflow created instantly short-term real exchange rate overvaluation. The data shows that some other developing countries, like Poland and Russia let their price level to adjust through depreciation of nominal exchange rate. Estonia and other Baltic countries decided to go through adjustment with deflation of prices and wages. This contributed to higher unemployment rate and GDP loss. The most positive way out appears to be restoration of foreign investors interest in local economy and raising equilibrium real exchange rate reducing likely real exchange rate overvaluation. The other important implication was that local businessmen and other individuals were too much risk-takers for volatile emerging market economy.