Currency Devaluation in Latvia: Costs and Future Projections

This report devotes itself to an analysis of how hypothetical currency devaluation would affect Latvia’s future competitive position from the perspective of labour market dynamics. The aim of this paper is to attempt to model and evaluate possible outcomes of currency devaluation using empirical as well as theoretical methods corresponding to short-run, medium-term and long-run. The chosen topic and scope of the research are relevant, since the issue as to how to regain competitiveness after the “credit boom” has been widely discussed between many economists and politicians in Latvia. Even though lately there have been several signs of recovery in terms of regained competitiveness as a result of contractionary fiscal policy implemented by the state, the country’s competitive position can still be seen as rather undercompetitive and still measures of devaluation are frequently called upon. However, no prior research has been conducted on the dynamic causalities among the labour, goods and assets markets. At first using the theory of equilibrium real exchange rate, the current competitive position of Latvia shall be determined, thereby allowing the authors to assess the necessity for such action. The labour market side will be dealt with by applying a series of dynamic models as well as investigating the wage-productivity relationship and its further implications. The goods and asset market side would be dealt with through inflationary effects that are likely to undermine the short-term impact on competitiveness. The collected data over the course of the research will be summarized and conclusions will be drawn upon the potential costs and effects after devaluing the lat.…