Policymakers and international financial institutions responded swiftly to the crisis—defusing the risk of full-scale currency crises and financial sector meltdowns. Given the scale of the adverse shocks and the vulnerabilities built up in the boom years, there was no escaping a major setback. However, an even worse outcome was avoided.
Policymakers moved quickly to stabilize their banking systems. Monetary policy was adjusted to either guard against excessive currency depreciation or stimulate domestic demand, depending on country circumstances, and fiscal balances were allowed to deteriorate, with a partial offset from consolidation measures in countries facing fiscal constraints.
Large amounts of external financing were made available by the IMF, the European Union, and other international financial institutions. The Fund provided the overall framework with nine IMF-supported programs in the region. A new Flexible Credit Line arrangement was also extended to Poland (see Table). As a result, a much feared exchange-rate overshooting, which could have deepened the crisis through adverse balance sheet effects, was avoided.
Exchange rate pegs generally held—only Russia and Ukraine saw themselves compelled to allow more exchange rate flexibility, and Belarus devalued. Most countries also managed to steer clear of a banking crisis, except for Latvia and Ukraine.
The crisis experience differed greatly among the countries of the region. While all countries suffered, Poland for example managed to avoid a recession while the Baltic countries and Ukraine saw double digit contractions of economic activity. As the IMF study explains, the size of the pre-crisis credit boom explains these divergent outcomes better than any other variable.
Lessons learned
The study draws several lessons from the boom-bust. Credit booms can be very costly—they bring high output volatility with deep recessions, and seen over a longer time period do not seem to be associated with higher average growth.
Mitigating credit booms through prudential measures is challenging, particularly in countries where the banking system is dominated by affiliates of foreign banks, and requires home-host supervisory cooperation to be effective.
The study also notes that a more active fiscal policy would have helped lessen overheating prior to the global financial crisis. But most countries treated buoyant revenues during the boom years as permanent and stepped up spending correspondingly rather than building fiscal buffers. Tighter fiscal policy would have been particularly helpful in highly financially integrated countries with pegged exchange rate regimes, where credit growth was particularly high and difficult to control because of a limited set of monetary policy tools.
These lessons point to one overarching policy conclusion, the study says: it will be important in the next boom to be skeptical about “this time is different” stories and maintain a cautious macroeconomic policy stance.
© International Monetary Fund
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