Anyone who has worked with transition economies will be familiar with the difficulty of finding stable macroeconomic relationships, and often of obtaining data to estimate such relationships. Besides being annoying for researchers, this poses a serious impediment to policymakers. Thus an important question is the extent to which a transition economy has "normalized," that is, to what extent have certain standard macroeconomic relationships emerged and become stable. Here we do not offer any general definition of normalization or of how to test it, but in a tentative search for normalization we look at one specific case related to the Latvian labor market.

We managed to obtain data on job vacancies in Latvia and used these, together with information about unemployment and inflation, to investigate two market economy relationships: the Beveridge curve, which posits a negative relationship between unemployment and vacancies, and the Phillips curve, which posits a similar relationship between inflation and unemployment. While it may be too early to identify a stable Phillips curve relationship, the Beveridge curve provides easily interpretable and useful information about the Latvian labor market and how it responded to the Russian crisis shock of 1998.

On August 17, 1998, Russia devalued the ruble and defaulted on Treasury bills and on interest payments to several Paris Club creditors. Within a year the ruble price of Latvian lats had more than quadrupled, a massive devaluation by any standards. Latvian exports to Russia reacted predictably: whereas Latvian exports to Russia had accounted for 21 percent of total exports in 1997, this figure had declined to only 7 percent in 1999 and 4.2 percent in 2001. GDP growth and unemployment reacted similarly.

Throughout 1997 and into 1998 Latvia had enjoyed high growth rates of 6 to10 percent per year, but growth dropped sharply in the third and fourth quarters of 1998, and was negative during the first two quarters of 1999. Then the economy rebounded, and since 2000 growth rates have again been sizable, suggesting that the effects of the Russian crisis are essentially over.

The unemployment rate, having hovered around 6 or 7 percent from 1995 through mid-1998, increased for 10 successive months starting in July 1998 and ending in April 1999. Thereafter, through December 2000, unemployment rates slowly decreased, or at least did not increase.

The GDP and unemployment effects seem to suggest the following:

GDP and unemployment trends responded to the negative economic shock of the Russian crisis in textbook fashion, which is not surprising given the aggregate nature of these indicators. Of interest, however, is whether other key relationships responded similarly.

We looked at the Phillips and Beveridge curves, with the latter being of particular interest to us (see the figures). The Phillips curve should be viewed with caution. The high inflation-low unemployment points represent early years, when inflation was higher but was adjusting downwards. The Russian crisis increased unemployment, but seemingly had little impact on inflation.

The Beveridge curve, however, seems readily interpretable. It represents the relationship between job vacancies and unemployment, reflecting the segmentation of the labor market. Because of skills differences, excess demand for one type of labor may coexist with excess supply of another type of labor. In Latvia the lack of geographical mobility results in another mismatch between the demand for and the supply of labor. Usually labor markets are characterized by large gross flows into or out of employment. The Beveridge curve, which shows the joint movement of job vacancies and the unemployment rate, can reveal interesting information about the matching process, that is, how the supply of labor may or may not match the demand for labor.

Two types of shocks affected the relationship:

The Russian crisis is an example of the former category, and the conclusions to be drawn from the relationship are relatively simple. With GDP growth increasing during 1997, the vacancy rate increased because of a higher demand for labor, but the unemployment rate barely fell, an interesting observation and one worthy of further study. The vacancy rate peaked in August 1998, just before the Russian crisis. Then, as the crisis hit, the unemployment rate increased sharply while the rate of vacancies fell, a response fully consistent with what one would expect from a negative economic shock. As unemployment peaked in April 1999, vacancies were apparently filled more easily. When the unemployment rate subsequently dropped again, reflecting the rather quick reversion to high economic growth, the demand for labor was again high, as reflected in a higher vacancy rate. Currently, the Beveridge relationship seems to have reverted to where it stood before the Russian crisis.

To sum up, the Beveridge curve indicates that the Latvian labor market behaved more or less as expected in a market economy. This is in contrast to the rather shapeless and erratic behavior observed before 1998. Our conclusions should offer encouragement to policymakers as well as suggest directions for future research.