Bengt Dennis: It's not banks' business to stabilize the countries
22.01.2009, 15:55 Responsibility for the economic imbalances
in the three Baltic countries lies with governments. Stabilization policy called
for by their absence, writes former governor of Swedish central
bank Bengt Dennis in DI Notebook.
The three Baltic countries are in a deep economic crisis. According to DI
columnist Gunnar Örn is the responsibility of SEB's CEO Annika Falk Gren and
Swedbank CEO Jan Lidén. They should have dealt with "direct monetary policy
mismanagement." In my opinion Gunnar Örn should have the spotlight on
governmental responsibility for stabilization policy.
The economic imbalances in the Baltic states did not come suddenly, they
originated for several years and strengthened with every passing year.
And it was topped for a long time by excessive domestic demand, which led to
inflation and cost increase was violent and current account deficit
unsustainable.
Competitiveness is weaker when not linked to productivity. Mistrust of the
prevailing exchange rates increased. Now is an inevitable shift of policy in all
countries, most clearly demonstrated by the IMF-led rescue operation for Latvia.
Warning signs were missing, but not met with silence or - as in Latvia, when
the crisis became clearer - with threats and attacks by the critics.
What would have been? Central banks can’t do much because of the prevailing
exchange rate regimes. The ability to switch to a more flexible currency system
wasn’t in their entry to ERM. Then there was a golden opportunity to move to the
broad band that is within the ERM, namely fluctuations up or down to 15 percent.
Instead, countries chose to stick to the old system that did not allow any
movement at all for the exchange rate - and in Latvia's case, the extremely
limited movement up or down at 1 percent.
When central banks can not act - given the exchange rate system in force - is
the responsibility of fiscal policy, that is, governments and parliaments. But
nothing or very little was done. As recently as last year was expansionary
fiscal policy in Latvia. Domestic demand continued to be strong to the end. What
happened in the Baltic region is closest to the textbook in nature.
The demand came in the way that was increasing the demand for credit
including stimulation by expectation of ever-rising asset prices. Demand for
credit was strong and the banks were willing to keep it up. Then the total
credit flow was so large it can not be blamed for individual banks.
Banks, regardless of national origin, can not sit in place and operate state
stabilization policy. In many countries, attempts have been made to rein in
credit expansion through so-called voluntary agreements, admonitions and various
kinds of pressure on banks. The outcome is always a magnificent flop.
The market is innovative and strong competition among banks. A collective
responsibility is impossible. The general experience, also from Sweden in the
early 1990s, by the way affect the credit expansion, that is, from the supply
side, is failures. Credit flow must be affected by the demand side - and it was
not in the Baltics.
Have banks made any mistakes? They could have realized earlier that the loans
would be significant losses. They could probably have done much to curb lending
in foreign currency, in any case in Latvia which had not the currency board.
Gunnar Örn is also criticizing "that bank lending has not gone to building a
competitive business." The political objective of the business direct control
bank lending to certain specified purposes by the State had called another
economic-political system, far removed from what these countries have created
and consistently worked for since liberation from the planned economy in the
Soviet era.
However, a balanced taxation certainly dampened lending to property sector.
My conclusion is that banks in general were too generous in their credit rating,
which now is punishing. This year and next year, banks will account for huge
losses in its Baltic lending, much greater than has so far emerged and
suggested. The ultimate responsibility for the economic imbalances - and the
total credit flow - is, however, of the governments that did not keep back
domestic demand.