Tito's Blog

Deflation Or Devaluation? Two Routes To The Same Destination

I recommend reading this analysis of Baltic states response to the crisis by Andrew Bosomworth of PIMCO.

So a large part of society without direct exposure to foreign currency debt – the young, old and companies in the tradable sector – is paying a high price to support those who borrowed foreign currency. Further cuts to the 2010 budget are looming. From the perspective of welfare, the cost of deflation associated with maintaining the fixed exchange rate suggests it is not an optimal position. In a democracy, the political system usually delivers what the public ultimately wants. As the welfare cost to society of maintaining the peg grows, public support for it will wane.

Often the vocal minority who suffers concentrated pain wins over a majority with widespread benefits.