Category Archives: Overshooting

ECB Bailout of Sweden/Latvia

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Today the Swedish Central bank was forced to take out an emergency loan from the European Central Bank (ECB). The ECB is not in the habit of issuing such loans to non-members (or members alike). The Guardian reports that the Swedish central bank borrowed €3bn from the ECB as the Latvian emergency causedripple effects.

What on earth could Latvia have to do with foreign currency troubles at the Swedish Central Bank?  Here is a possible answer: the very same day, the very same newspaper (Financial Times) reports that 

a) The ECB intervened to avert a Baltic financial crisis, since Swedish banks dominate the the Baltic financial sector. 

and 

b) Swedish banking shares rose sharply after the Swedish Central Bank announced that the nation's banks would be able to weather "extreme" pressures domestically and abroad.

Nouriel Roubini provides his assessment of the Lativan crisis and solution.  Mary Stokes focusses on contageon.

1) Outline how the Latvian Crisis is undermining the Swedish Economy 

2) Discuss why either the term "extreme" or "abroad" seems to be inconsistent with the message. 

3) Use the Mundell Flemming model to trace Roubini's fear of overshooting. 

4) Why would contageon justify the ECB's intervention to aid Swedish banks that are overexposed in Latvia?

 


 

 

 

 

 

 

 

 

 

 

 

 
 
Text in Latvian:
[EU driver] Hop in! We are taking the same route!

[Latvian cyclist] No! Can do it myself! 

Cartoon: Gatis Šļūka 

A New World Order?

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Times change: development advice will never be the same again. Why would any country buy the bitter medicine to limit goverment debt or forgo purchases of goverment debt by the country's central bank? Industrialized countries, who have strongly pushed such strong medicine, now instruct their central banks to purchase goverment debt and generate unprecedented fiscal deficits. The justification: extraordinary economic times. I would bet that any finance minister of a country where the majority of citizens lives on a dollar would argue that s/he is facing extraordinary times…  

The response to industrialized countries' policies has been swift. Credit rating agencies warn the UK goverment that it is in danger of loosing its pristene bond rating (because of excessive debt) and the US is being lectured about the dangers of printing money (by a developing country).

Interest parity can help us predict the future value of the British Pound (what is your prediction of the forward premium?). The Mundell Fleming Model (augmented to include price changes, see Chapter 19) or the Dornbush Overshooting Model (Chapter 20) come in handy to understand fluctuations in output, prices, and exchange rates as the US Central Bank engages in purchases of massive amounts of treasury bills to inject liqudity into the US economy. 

Back to development advice: the events remind me of the cafeteria at the IMF's Washington D.C. headquarters in the 1980s, where meals were ridiculously subsidized, but every IMF program advised developing countries against subsidizing food.