In the early 1990s, Finland experienced a severe recession in which real GDP decreased by 14% and the unemployment rate increased from 3% to nearly 20%. The causes of the depression were in some ways similar to the causes of the 2007–2009 recession in the United States: Earlier financial deregulation led to a boom, in this case largely financed by foreign borrowing. An asset boom caused the prices of most assets, including real estate and stock, to increase rapidly. In addition, the Soviet Union collapsed in 1991, Finland lost its largest trading partner, and at the same time, bank regulations changed, tightening credit standards.
a. Explain the effect of a large decrease in international trade on the economy of Finland.
b. Explain the effect of a tightening of credit standards.
c. Use the IS–MP model to show why Finland experienced a depression.