Great, Greater, Greatest – Three Finnish Depressions

Brad DeLong has suggested that we rename the Great Recession the GreatER Depression in Europe as the crisis in terms of real GDP lose now is bigger in Europe than it was it during the Great Depression.

Surely it is a very simplified measure just to look at the development in the level of real GDP and surely the present socio-economic situation in Europe cannot be compared directly to the economic hardship during the 1930s. That said, I do believe that there are important lessons to be learned by comparing the two periods.

In my post from Friday – Italy’s Greater Depression – Eerie memories of the 1930s – I inspired by the recent political unrest in Italy compared the development in real GDP in Italy during the recent crisis with the development in the 1920s and 1930s.

The graph in that blog post showed two things. First, Italy’s real GDP lose in the recent crisis has been bigger than during 1930s and second that monetary easing (a 41% devaluation) brought Italy out of the crisis in 1936.

I have been asked if I could do a similar graph on Finland. I have done so – but I have also added the a third Finnish “Depression” and that is the crisis in the early 1990s related to the collapse of the Soviet Union and the Nordic banking crisis. The graph below shows the three periods.

Three Finnish Depressions

(Sources: Angus Maddison’s “Dynamic Forces in Capitalist Development” and IMF, 2014 is IMF forecast)

The difference between monetary tightening and monetary easing

The most interesting story in the graph undoubtedly is the difference in the monetary response during the 1930s and during the present crisis.

In October 1931 the Finnish government decided to follow the example of the other Nordic countries and the UK and give up (or officially suspend) the gold standard.

The economic impact was significant and is very clearly illustrate in the graph (look at the blue line from year 2-3).

We have nearly imitate take off. I am not claiming the devaluation was the only driver of this economic recovery, but it surely looks like monetary easing played a very significant part in the Finnish economic recovery from 1931-32.

Contrary to this during the recent crisis we obviously saw a monetary policy response in 2009 from the ECB – remember Finland is now a euro zone country – which helped start a moderate recovery. However, that recovery really never took off and was ended abruptly in 2011 (year 3 in the graph) when the ECB decided to hike interest rate twice.

So here is the paradox – in 1931 two years into the crisis and with a real GDP lose of around 5% compared to 1929 the Finnish government decided to implement significant monetary easing by devaluing the Markka.

In 2011 three  years into the present crisis and a similar output lose as in 1931 the ECB decided to hike interest rates! Hence, the policy response was exactly the opposite of what the Nordic countries (and Britain) did in 1931.

The difference between monetary easing and monetary tightening is very clear in the graph. After 1931 the Finnish economy recovered nicely, while the Finnish economy has fallen deeper into crisis after the ECB’s rate hikes in 2011 (lately “helped” by the Ukrainian-Russian crisis).

Just to make it clear – I am not claiming that the only thing import here is monetary policy (even though I think it nearly is) and surely structural factors (for example the “disappearance” of Nokia in recent years and serious labour market problems) and maybe also fiscal policy (for example higher defense spending in the late-1930s) played role, but I think it is hard to get around the fact that the devaluation of 1931 did a lot of good for the Finnish economy, while the ECB 2011’s rate hikes have hit the Finnish economy harder than is normally acknowledged (particularly in Finland).

Finland: The present crisis is The Greatest Depression

Concluding, in terms of real GDP lose the present crisis is a GreatER Depression than the Great Depression of the 1930s. However, it is not just greater – in fact it is the GreatEST Depression and the output lose now is bigger than during the otherwise very long and deep crisis of the 1990s.

The policy conclusions should be clear…

PS this is what the New York Times wrote on October 13 1931) about the Finnish decision to suspend the gold standard:

“The decision of taken under dramatic circumstances…foreign rates of exchange immediately soared about 25 per cent”

And the impact on the Finnish economy was correctly “forecasted” in the article:

“In commercial circles it is expected that the suspension (of the gold standard) will greatly stimulate industries and exports.”

HT Vladimir

Related post:
Currency union and asymmetrical supply shocks – the case of Finland

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  1. Would you mind if I translated this into Finnish and published it on Finnish blog platform, with the usual credits and backlinks?

  2. BTW, you fail to mention that the 90’s depression in Finland was largely caused by “strong Finnish markka / internal devaluation”-policy, which was aggravated by linking the markka to the ECU. Note how after an insufficient devaluation in 1991, switching to a regime of free float in 1992 September finally turned the tide.

    (Protecting the markka exchange rate meant keeping nominal interest rates high during the late eighties/early nineties, and corporations and households turned to foreign currency-loans).

    The economic policies were so bad, that the politicians had to put the blame for all the troubles on the “tiny, feeble” Finnish markka, and that is the official consensus even today.

  3. I knew you knew – just wanted to point it out to readers.

  4. You won’t be invited to write a economic programme by the Finnish government if you do! The euro is holy and saved us from the high interest rates and the never-ending depression that was caused by the markka. All hail the euro.

  5. I found your post incredibly interesting and educating. And please, do write about the 1990s monetary policy failure.

  6. Presented your excellent remarks in my blog. Added my personal view that in addition to ECBs ill-timed rate hike in 2011, excessive austerity killed any hopes of recovery – since 55 % of Finnish exports (would) go to Eurozone. So here, in Finnish:

  7. follower from the side

     /  November 17, 2014


    1. Finland has extremely large public sector over 60% off all GDP
    2. Companys dont like to take part in current economic crises and world hardest taxation -> move abroad ->sky rocketing unemployment
    3. See finnish “eduskunta” or the parlament, most are retirees who like to keep services and retirements as high as possible for them selfs -> no cuts -> rolled to the next generations
    4. Payment trap has been voted to younger generatios, baby boomers retired at 60-63, anyone born after 1955 retirements up to 71-73 years
    -> younger generatios move abroad, who are left behind like retire on health reasons or collect benefits since salaries bying power has dropped dramatically past 10 years, same time taxes have skyrocketed in energy and transportation, cost off basic needs have risens 10-80% including food
    5.there is no any way affect situation by voting since most people collect more benefits and retirements from the goverment -> no change
    6.all the talk coming out from the “talking heads” focus on something else that te core off the problem, too high taxes, too many working for public sector and too rigid laws, so anything new can be brought in…. dept:

    100mrd goverment dept
    120mrd counties dept (kuntarahoitus)
    100mrd Private sector dept + companies dept

    8. promises to pay

    +150-250mrd in future retirements
    +80mrd aid to the European union
    ++who knows what

    so official 60% dept rate to GDP…LOL

    and yes, prime minister and president have announced officially on TV that economic situation is on the verge….

  8. > The policy conclusions should be clear…

    What is the policy conclusion for Finland? Based on the analysis, yes, some sort of a devaluation or monetary easing would do the trick.

    But ECB will follow the average needs of the euro area, not the specific needs of Finland. If the central countries are doing fine, there is no point in changing the policy just to please Finland. And even if the policy changes in the direction that Finland needs, the changes would make all euro countries more competitive, and Finland could still be the least competitive of them.

    Some people have proposed to leave euro. I think that would help in the same way as leaving the gold standard and floating the markka did. But that is probably out of question to the Finnish politicians, and would remove also the benefits of euro.

    The third alternative is some sort of internal devaluation. Since that actually means cutting salaries, politicians don’t want to even mention this alternative. This could however be the least painful approach. If the country is generally not competitive (not just temporarily, waiting for the next upswing, but in a more permanent way), this is the most obvious solution. Actually all countries that decide use a common stable currency should be prepared to do also something like this when their economy permanently lags behind the others.

    Yes, long term structural improvements too, but that’s the long term plan. Finland needs also a short term package to put it back on track.

  9. Juho Laatu: the real problem is that the ECB has not been, is currently not and probably won’t follow the average needs of the euro area. Your statement that even if the ECB would ease policy, making life a bit nicer for everyone, it would still leave the relative differences between the countries intact. But that misses the point – if there is a tolerance limit for a country (e.g. too low inflation, NGDP…) that it cannot sustainably fall below, it will not be able to adjust. Greece is a prime example of this.

    Thus either the common policy “for the average euro area” must overshoot so that even the weakest members can follow, or alternatively the policy must be fragmented (remember LTRO, ELA, dubious collateral requirements from the ECB? Or how bailouts, deficit limits and so on get differential treatment?). The ultimate fragmented (targeted) form of a currency union is not to have a currency union, leaving every country free to pursue monetary or economic targets by any means necessary.

    The “internal devaluation route” that you vouch for has been done in theory and in practice, and it never worked well. The examples are fresh.

    In my opinion, the more fragmented is more adaptable and thus preferable. My second choice would be an overshoot. The internal devaluation should be the a choice of last resort.

    • Juhani Huopainen:

      If fragmentation means separate currencies, that would work. But I’m also interested in seeing if we can find means to make a common currency work. Now it clearly is still missing something.

      I think the original neutral and stable euro was better than the current one with a politically active ECB that makes political (inner circle) decisions on which countries to please and what policy to follow. The overshooting policy could be an option too, but I like a stable currency more. The overshooting policy could mean e.g. continuous inflation that is faster than salary raises in any of the euro countries (minus growth). Sounds old-fashioned.

      What I’m interested to test is a stable common currency but where each country has its own adjustment screws. Salary cuts could be one. They could be acceptable everyday business too, just like devaluations and floating national currencies once were. Slow gradual cuts would be better than large surprise cuts.

      I don’t know Ireland’s history very well, but I have understood that salary cuts were a working part of Ireland’s recovery.

      • Many things would be interesting, no doubt. The case against internal devaluation and flexible wages is strong. I think you have misunderstood what “stability” means, or what kind of stability is preferable in an economy. If running a higher inflation in order to avoid nominal wage cuts sounds old-fashioned, I would counter that line by saying that you probably haven’t done your two credit weeks of macroeconomics. Some things are old because they work. Beware postmodernist impulses.

        I think it is dangerous and not stability-inducing to prefer something just because it sounds modern or would be interesting. We already ran the experiment of a currency union and we saw that wages are not flexible, and the end result was high unemployment rates and deflationary spirals. Just like many times in the past as well.

        The only way how flexible wages would work IMHO is a basic income system.

  10. Juhani Huopainen:

    Actually I think that the economists and politicians have not done their homework. When they said (before euro) that common currency is the way to go, I thought that they had carefully considered and planned what to do when the economy of one of the member states weakens. But obviously not. How on earth do they think that they can continue paying salaries that are higher than the country can afford (in a situation where there is no country specific devaluation). That’s why I don’t trust their opinions on how to solve the crisis either.

    I think I agree with you on that the euro system has not been well planned. And in my opinion it has gone worse, although the politicians claim that they have now fixed the problems of euro when they changed the rules (no bailout, stable currency etc.). I think they have rather introduced flaws to an (earlier) incompletely understood system.

    • The warnings from the economists were readily available. Mundell’s theory of optimal currency area was well-known. The Finnish EMU-working group warned about asymmetrical shocks and the lack of policy tools within a monetary union. So did the Swedish group. And US economists, and the Brits. It was the politicians who did not pay attention, and, sadly, many economists sensed that it would be a good career move to tell the politicians what they wanted to hear. It happens.

      So I disagree with your thinking that the economists did not know. They knew, many of them said it but the politics won. In a sense, the euro is populism, while opposing it is not (if populism is defined as a fallacy).

      I’ve said it for a long, long time: it’s either 1) a well-planned orderly breakup or disorderly breakup 2) full monetary union with fiscal transfers, mutual debt etc or 3) very, very long and deep recession.

      I guess we are about half-way in the current euro area’s recession (since 2008). Some might say that it is worth going through the rest of the recession in order to get to the wonderful land of plenty. Unfortunately, the euro remains just as borked after this recession as it was before it. There will be another euro crisis, and then another, and at some point the system will not hold. The euro is not a stable state.

      The full union sounds implausible. Will Germans be ready to finance the rest of the continent? Will other countries put up with the rules that Germany would require? Will voters in every country support it?

      I guess the most probable path will be a continuation of this recession for a long time, and when things finally get bad enough, some member will try to leave.

      Brookings had a very good paper discussing these problems: and here’s a link to the full doc:

      • I’m sure someone has warned about every possible risk in euro. There is always someone who says that he kew it all beforehand. The problem is that political decisions are made by people who obviously do not have any stable understanding of the nature and mechanics of the system that they are supposed to lead.

        If the politicians do not understand, but some other players with different interests do, the system will probably be different from what we want and what the politicians say it is.

        Your three alternative scenarios seem quite plausible to me. It seems that you think that the following additional scenario can not work. 4) A stable common currency with no deep union, and with country specific actions to balance the economy of each country in economic up and downturns. I think this would be quite possible too. But I do believe that those in power (political, economical, administrational) are more likely to favour solutions that centralize power and give it to the inner circles.

  1. Assorted links
  2. “Suomessa on nyt kaikkien aikojen pahin lama “ | Arjen polku
  3. Suomi-neito on tyypillinen perheväkivallan uhri – uskoo omaan syyllisyyteensä | Tyhmyri's Blog
  4. Suomi Japanin tiellä | Talouden tulkki
  5. Pentti Haanpää, U.T. Qwist ja 2010-luku | Hurmosta, huomiota ja hyvää mieltä
  6. The Euro – A Fatal Conceit | The Market Monetarist
  7. The Euro——A Fatal Conceit | David Stockman's Contra Corner
  8. The Euro – A Fatal Conceit « Financial Survival Network
  9. Le péché originel de l’euro | Contrepoints
  10. Le péché originel de l’euro | Actu Internationnal
  11. Finland continued economic nightmare | The Market Monetarist
  12. The Euro – A Fatal Conceit - European
  13. Finland continued economic nightmare - European

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