Thursday, May 14, 2009

An Austrian Economics Lesson from Latvia

Stephan Karlsson points out that Latvian GDP declined 10.8% in Q4 2008 and 18% in Q1 2009.

What's behind the dramatic drop? It's usually about the money.

Karlsson writes:

The main reason for this depression is the sudden shift from a real money supply growth of about 30% during the boom years, to a contraction in real money supply of more than 20% in the year-to=date March 2009. That reflects both a 17.8% nominal money supply contraction and a price inflation rate of 8.2%. Latvia's depression is thus an extreme but clear real life illustration of the Austrian business cycle theory
Austrian business cycle theory, of course, says that a booming economy during a period on money inflation distorts the economy and that a downturn comes about when the economy begins to readjust once the money printing has slowed.

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