The Financial Crisis in Europe: A Comparative Analysis of Latvia and Cyprus

Abstract

The financial crisis in Latvia and Cyprus shared many important characteristics and they both underwent similar crisis with significant help from international partners. Latvia underwent internal devaluation while Cyprus employed capital controls, as a strategy for dealing with the crisis. This paper analyses these two countries and the strategies they employed in a comparative perspective. A central conclusion is that while internal devaluation is possible in principle, it is very hard to achieve in the real economy and entails huge social consequences. Capital controls can provide governments with breathing space but has to be followed by comprehensive reforms to correct the macroeconomic imbalances that have accumulated in the economy.