Economic recession in transitional EU countries under the currency board arrangement: Lithuania's case

Abstract

New European Union member countries are experiencing a serious economic downturn brought on by growing internal and external imbalances. The financial crisis, which has intensified, has led to worsen funding conditions, deterioration in the confidence of economic agents and a dramatic fall in world trade, in that way straightening out a global recession. Governments worldwide started measures to stabilize the financial systems and promote economic activity, which helped prevent a further escalation of the financial crisis. In view of the reality that economic incentive measures require some time to take full effect, a deep recession must be predictable for next years. An economical recession especially puts pressure on countries with the currency board (CB) arrangements. Currency board provides central banking out of work for interest and exchange rate determination. Thereby, monetary policy is in reality outsourced. Foreign direct investment (FDI) in banking sector led to outsourcing of the second important central bank function, responsibility for banking supervision. Lithuania’s and other Baltic States’ experience with the CB and expanding foreign involvement in banking is reviewed. Empirical evidence from Argentina’s CB during the crisis is discussed. The conclusion outlines the possible circumstances for currency board survival during a global economic recession in the new EU member states.