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The ongoing financial crisis has put euro adoption at the top of Estonia's policy agenda. However, shocks affecting Estonia are only weakly synchronized with those of the euro area, and the structure of its economy also notably differs from the euro zone.
This working paper begins with a discussion of the factors that made the banks, non-financial firms and households vulnerable to deterioration in global financial markets. It then describes the failure of the banks, its direct impact on government debt, the IMF SBA and the economic outlook.
As attention shifts to fiscal consolidation, sustaining output growth will depend increasingly on private domestic demand, requiring reforms, particularly in the labour market and the non-manufacturing sector.
In contrast to the once prevailing norm of secrecy and opaqueness, transparency has now become one of the main features characterising the conduct of monetary policy.
Emergency measures adopted in the wake of the global crisis should be phased out once a recovery is in place, while adopting reforms to address chronic problems in the financial sector and increase efficiency.
The EU economy has experienced a deep economic slump. Ongoing financial reforms and the structural reform agenda must be pursued to make future crises less likely and improve growth prospects.
Iceland’s main banks, which had pursued risky expansion strategies, failed in the wake of the global financial crisis, plunging the economy into a deep recession. Prudential supervision needs to be improved.
Inflation performance has been unsatisfactory. By joining the euro area, Iceland would share the benefits of the ECB’s credibility. Substantial fiscal consolidation is required following the financial crisis.
There is a case, but there are also counter-arguments. With sufficient forward-looking behaviour among firms and households, price-level targeting can act as a powerful built-in stabiliser through automatic shifts in inflation expectations.
High public debt leaves virtually no room for fiscal manoeuvre to limit the impact of the crisis in Greece. The close trade and banking links established with the Balkan countries might be a risk in the near future.