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Capital Inflows, Household Debt And The Boom Bust Cycle In Estonia

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  • Zuzana Brixiova

    ()

  • Laura Vartia

    ()

  • Andreas Woergoetter

    ()

Abstract

From 2000 to 2007, Estonia was one of the fastest growing emerging market economies. A housing boom, fuelled by capital inflows and credit, resulted in skyrocketing house prices and an over-expanded construction sector. However, the currency board limited the Bank of Estonia’s ability to curb credit growth, while the fiscal policy framework amplified the cycle through pro-cyclical spending increases and tax cuts. As credit was mostly financed by cross-border loans from foreign banks, the risks of disruptions to credit flows and financial contagion have increased. Some have already materialised through tightened lending standards and capital outflows. Estonia is now in a severe recession. To restore high and sustainable growth, the country will need to rebalance its resources from non-tradables towards exports. Regaining external competitiveness will be challenging, however, given the fixed exchange rate and recent devaluations in partner countries. Flexibility of the economy will thus be crucial. Over the medium term, policymakers could also strengthen incentives for a better functioning of the housing finance market and gradually remove the pro-cyclical bias of fiscal policy.

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Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number wp965.

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Length: pages
Date of creation: 01 Jul 2009
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Handle: RePEc:wdi:papers:2009-965

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Keywords: capital inflows; credit; household debt; boom-bust cycle; Estonia;

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  1. Reinhart, Carmen & Kaminsky, Graciela & Vegh, Carlos, 2004. "When it rains, it pours: Procyclical capital flows and macroeconomic policies," MPRA Paper 13883, University Library of Munich, Germany.
  2. Nils Jannsen, 2009. "National and International Business Cycle Effects of Housing Crises," Kiel Working Papers 1510, Kiel Institute for the World Economy.
  3. Bal�zs �gert & Dubravko Mihaljek, 2007. "Determinants of House Prices in Central and Eastern Europe," Comparative Economic Studies, Palgrave Macmillan, vol. 49(3), pages 367-388, September.
  4. Amato, Jeffery D. & Furfine, Craig H., 2004. "Are credit ratings procyclical?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(11), pages 2641-2677, November.
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  8. Robert A. Eisenbeis, 2006. "Home country versus cross-border negative externalities in large banking organization failures and how to avoid them," Working Paper, Federal Reserve Bank of Atlanta 2006-18, Federal Reserve Bank of Atlanta.
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Cited by:
  1. Jaan Masso & Jaanika Meriküll & Priit Vahter, 2011. "Gross Profit Taxation Versus Distributed Profit Taxation And Firm Performance: Effects Of Estonia’S Corporate Income Tax Reform," University of Tartu - Faculty of Economics and Business Administration Working Paper Series, Faculty of Economics and Business Administration, University of Tartu (Estonia) 81, Faculty of Economics and Business Administration, University of Tartu (Estonia).
  2. Josef C. Brada & Trajko Slaveski, 2012. "Transition in a Bubble Economy," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., M.E. Sharpe, Inc., vol. 48(S4), pages 7-13, November.
  3. Sandrine LEVASSEUR, 2012. "Labour market adjustments in Estonia during the 2008/2011 crisis," Eastern Journal of European Studies, Centre for European Studies, Alexandru Ioan Cuza University, Centre for European Studies, Alexandru Ioan Cuza University, vol. 3, pages 123-143, June.
  4. Christophe André, 2010. "A Bird's Eye View of OECD Housing Markets," OECD Economics Department Working Papers 746, OECD Publishing.
  5. Brzoza-Brzezina, Michał & Jacquinot, Pascal & Kolasa, Marcin, 2010. "Can we prevent boom-bust cycles during euro area accession?," Working Paper Series, European Central Bank 1280, European Central Bank.
  6. Ivo Karilaid & Tõnn Talpsepp, 2010. "Can policy improve liquidity during a financial crisis?," Baltic Journal of Economics, Baltic International Centre for Economic Policy Studies, Baltic International Centre for Economic Policy Studies, vol. 10(2), pages 5-26, December.
  7. Sandrine Levasseur, 2011. "Labour market adjustments in Estonia during the global crisis," Sciences Po publications 2011-25, Sciences Po.
  8. Jaan Masso & Kerly Krillo, 2011. "Labour Markets In The Baltic States During The Crisis 2008-2009: The Effect On Different Labour Market Groups," University of Tartu - Faculty of Economics and Business Administration Working Paper Series, Faculty of Economics and Business Administration, University of Tartu (Estonia) 79, Faculty of Economics and Business Administration, University of Tartu (Estonia).
  9. Masso, Jaan & Meriküll, Jaanika & Vahter, Priit, 2013. "Shift from gross profit taxation to distributed profit taxation: Are there effects on firms?," Journal of Comparative Economics, Elsevier, vol. 41(4), pages 1092-1105.
  10. Anne Lauringson, 2011. "Unemployment Benefits In A Period Of Crisis: The Effect On Unemployment Duration," University of Tartu - Faculty of Economics and Business Administration Working Paper Series, Faculty of Economics and Business Administration, University of Tartu (Estonia) 82, Faculty of Economics and Business Administration, University of Tartu (Estonia).
  11. Gedeon Shirley, 2010. "The Political Economy of Currency Boards: Case of Bosnia and Herzegovina," South East European Journal of Economics and Business, De Gruyter Open, De Gruyter Open, vol. 5(2), pages 7-20, November.
  12. Ardo Hansson & Martti Randveer, 2013. "Economic adjustment in the Baltic Countries," Bank of Estonia Working Papers, Bank of Estonia wp2013-1, Bank of Estonia.
  13. A. Bethlendi, 2011. "Policy measures and failures on foreign currency household lending in central and eastern Europe," Acta Oeconomica, Akadémiai Kiadó, Hungary, Akadémiai Kiadó, Hungary, vol. 61(2), pages 193-223, June.
  14. Jaan Masso & K. Espenberg & Anu Masso & I. Mierina & Kaia Philips, 2013. "GINI Country Report: Growing Inequalities and their Impacts in the Baltic States Estonia, Latvia, Lithuania," GINI Country Reports, AIAS, Amsterdam Institute for Advanced Labour Studies baltics, AIAS, Amsterdam Institute for Advanced Labour Studies.
  15. Sandrine Levasseur, 2011. "labour markets adjustments in Estonia during the global crisis," Documents de Travail de l'OFCE, Observatoire Francais des Conjonctures Economiques (OFCE) 2011-25, Observatoire Francais des Conjonctures Economiques (OFCE).

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