Managing fixed Exchange rates in a time of crisis: the case of Latvia

The global financial crisis catalyzed burst of the bubble of overheated Latvian economy. Accrued macroeconomic imbalances and obvious asymmetry between nominal and real exchange rates of the national currency caused outspreading of well – grounded speculations regarding devaluation of the Latvian lats as most suitable solution for evidently necessary macroeconomic adjustment. Though, the Bank of Latvia emphatically rejected any possibility of stepping down from the exchange rate peg. Moreover, through the communications of nearly propagandic nature the Bank of Latvia has persuaded the population that devaluation of the Latvian lats would only harm the entire economy. As a result, for the sake of stability of the national currency, Latvia chose the path of internal devaluation, notwithstanding that it would most likely lead to painful U shape adjustment, instead of V shape adjustment via external devaluation. However, internal devaluation did not sort out all problems, because external stability of the exchange rate was still be endangered by uncertainties.