Working Paper: NBER ID: w14874
Authors: Yuriy Gorodnichenko; Enrique G. Mendoza; Linda L. Tesar
Abstract: During the period 1991-93, Finland experienced the deepest economic downturn in an industrialized country since the 1930s. We argue that the culprit behind this Great Depression was the collapse of Finnish trade with the Soviet Union, because it induced a costly restructuring of the manufacturing sector and a sudden, large increase in the cost of energy. We develop and calibrate a multi-sector dynamic general equilibrium model with labor market frictions, and show that the collapse of Soviet-Finnish trade can explain key features of Finland's Great Depression. We also show that Finland's Great Depression mirrors the macroeconomic dynamics of the transition economies of Eastern Europe. These economies experienced a similar trade collapse. However, as a western democracy with developed capital markets and institutions, Finland faced none of the large institutional adjustments that other transition economies experienced. Thus, by studying the Finnish experience we isolate the adjustment costs due solely to the collapse of Soviet trade.
Keywords: Finnish Great Depression; Soviet Union; Trade Collapse; Energy Prices; Dynamic General Equilibrium
JEL Codes: E32; F41; P2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| collapse of trade with the Soviet Union (P33) | Finland's Great Depression (G01) |
| collapse of trade with the Soviet Union (P33) | costly restructuring of the manufacturing sector (L16) |
| collapse of trade with the Soviet Union (P33) | significant increase in energy costs (Q41) |
| real wage rigidity (J31) | exacerbation of the downturn (F44) |
| real wage rigidity (J31) | deeper declines in output and employment (E24) |
| collapse of trade with the Soviet Union (P33) | decline in output (E23) |
| real wage rigidity (J31) | milder recession without wage rigidity (E69) |
| trade shocks (F14) | detrimental effects on Eastern European transition economies (P29) |