Capital Inflows, Household Debt and the Boom Bust Cycle in Estonia

29 Pages Posted: 16 Oct 2009

See all articles by Zuzana Brixiova

Zuzana Brixiova

International Monetary Fund (IMF) - European Department; African Development Bank

Laura Vartia

Organization for Economic Co-Operation and Development (OECD) - Economics Department (ECO)

Andreas Woergoetter

Organization for Economic Co-Operation and Development (OECD) - Economics Department (ECO)

Date Written: July 15, 2009

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.

Suggested Citation

Brixiova, Zuzana and Vartia, Laura and Woergoetter, Andreas, Capital Inflows, Household Debt and the Boom Bust Cycle in Estonia (July 15, 2009). William Davidson Institute Working Paper No. 965, Available at SSRN: https://ssrn.com/abstract=1489625 or http://dx.doi.org/10.2139/ssrn.1489625

Zuzana Brixiova (Contact Author)

International Monetary Fund (IMF) - European Department ( email )

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African Development Bank ( email )

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Laura Vartia

Organization for Economic Co-Operation and Development (OECD) - Economics Department (ECO) ( email )

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France

Andreas Woergoetter

Organization for Economic Co-Operation and Development (OECD) - Economics Department (ECO) ( email )

2 rue Andre Pascal
Paris Cedex 16, MO 63108
France

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