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

  • Zuzana Brixiova

    ()

  • Laura Vartia

    ()

  • Andreas Woergoetter

    ()

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
Date of revision:
Handle: RePEc:wdi:papers:2009-965
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  1. Guy Debelle, 2004. "Household debt and the macroeconomy," BIS Quarterly Review, Bank for International Settlements, March.
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  7. Edward E. Leamer, 2007. "Housing IS the Business Cycle," NBER Working Papers 13428, National Bureau of Economic Research, Inc.
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  10. 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.
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  12. Nils Jannsen, 2009. "National and International Business Cycle Effects of Housing Crises," Kiel Working Papers 1510, Kiel Institute for the World Economy.
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