Internal devaluation and its macroeconomic consequences in the EU periphery - a comparison of the Iberian and Baltic countries

The global financial crisis and the euro crisis had a severe negative impact on the European economy and highlighted a key problem - loss of external devaluation - for currency unions and fixed exchange rate regimes. In the absence of an exchange rate policy, the adjustment and the restoration of competitiveness can exclusively happen through the process of internal devaluation. Internal devaluation is a painful adjustment; the reduction of wages and prices has substantial harmful effects on the economy, such as sluggish economic growth or recession, high unemployment rate and permanent budgetary deficit. In this article, we examine five countries - Iberian and Baltic - and show how internal devaluation was accomplished through their economies. In the case of Iberian countries, a prolonged crisis evolved and the process of internal devaluation exacerbated the economic situation, while in the Baltic countries a rapid downturn was followed by a sharp recovery. A simple empirical assessment shows that internal devaluation worked in the southern periphery and a moderate improvement started.