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Lessons from Finland's Depression of the 1990s: What Went Wrong in Financial Reform?

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  • Pekka Ahtiala
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    Abstract

    The role of economic policy in Finland's depression of the 1990s is analyzed with a simple model of an open economy, and the conditions for a successful financial reform derived: Let the system adjust after the removal of interest rate ceilings, and the domestic interest rate then be aligned with foreign rates before liberalizing international capital flows. In Finland, the financial system was liberalized simultaneously with international capital movements, with the domestic shadow interest rate initially considerably higher than the international market rates. A capital inflow the size of the monetary base followed, leading to the 'crazy years' of 1987-89. With a large current account deficit, the Bank of Finland tightened money sharply, causing a banking crisis practically wiping out the savings bank sector. The GDP declined by 13%. Several lesser policy measures aggravated the crisis.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13841280500512995
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Journal of Economic Policy Reform.

    Volume (Year): 9 (2006)
    Issue (Month): 1 ()
    Pages: 25-54

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    Handle: RePEc:taf:jpolrf:v:9:y:2006:i:1:p:25-54

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    Related research

    Keywords: Financial reform; Finland's depression of the 1990s;

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    1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
    2. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
    3. Rudiger Dornbusch, 1988. "Real Exchange Rates and Macroeconomics: A Selective Survey," NBER Working Papers 2775, National Bureau of Economic Research, Inc.
    4. Karras, Georgios, 1994. "Government Spending and Private Consumption: Some International Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 9-22, February.
    5. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2000. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," CEPR Discussion Papers 2529, C.E.P.R. Discussion Papers.
    6. Krugman, P., 1993. "What Do We Need to Know About the International Monetary System?," Princeton Studies in International Economics 190, International Economics Section, Departement of Economics Princeton University,.
    7. Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries," NBER Working Papers 3372, National Bureau of Economic Research, Inc.
    8. Ahtiala, Pekka, 2000. "Does the Maastricht Public Debt Criterion Call for Fiscal Expansion or Contraction?," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 15, pages 397-417.
    9. Bertola, Giuseppe & Drazen, Allan, 1991. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," CEPR Discussion Papers 599, C.E.P.R. Discussion Papers.
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