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Inflation Increase in Latvia: A Short-Term Phenomenon or a Risk Associated with Demand Pressure?

Inflation Increase in Latvia: A Short-Term Phenomenon or a Risk Associated with Demand Pressure?. Christoph B. Rosenberg Senior Regional Representative International Monetary Fund Warsaw Regional Office. HICP in Latvia vs. Baltics*, EU8*, EU15, Scandinavia . (YoY, in percent). Latvia.

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Inflation Increase in Latvia: A Short-Term Phenomenon or a Risk Associated with Demand Pressure?

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  1. Inflation Increase in Latvia: A Short-Term Phenomenon or a Risk Associated with Demand Pressure? Christoph B. RosenbergSenior Regional Representative International Monetary FundWarsaw Regional Office

  2. HICP in Latvia vs. Baltics*, EU8*, EU15, Scandinavia (YoY, in percent) Latvia Baltics EU8 EU15 Scandinavia 9 8 7 6 5 4 3 2 1 0 -1 Jul 2002 Jul 2003 Jul 2001 Jul 2004 Jul 2000 Jan 2002 Jan 2003 Jan 2005 Jan 2004 Jan 2000 Jan 2001 Apr 2002 Apr 2003 Apr 2005 Apr 2004 Apr 2000 Apr 2001 Oct 2002 Oct 2003 Oct 2004 Oct 2001 Oct 2000 Latvia's Inflation in Perspective *Baltics and EU8 exclude Latvia. Source: Eurostat.

  3. The SDR Peg and Inflation (a)

  4. The SDR Peg and Inflation (b) Notes: NEER weights assume that imports from EU are priced in Euro, non-EU imports priced in dollars. Contributions to HICP estimated using weights based on imports to GDP ratios in each country. *Jul-Dec Source: Eurostat.

  5. Supply-Side Effects Source: National authorities.

  6. Catch-Up to EU Price Levels (a) Relative price level vs. relative GDP per capita (PPP), 1995-2004 Source: Eurostat.

  7. Catch-Up to EU Price Levels (b) Source: Eurostat.

  8. Structural Factors

  9. Domestic Demand Pressures Source: Eurostat.

  10. Simulation: The Effect of Domestic Credit Growth

  11. Second-Round Effects –Inflation Expectations

  12. Second-Round Effects – Wage Setting

  13. Second-Round Effects –Wage Setting Source: CSO.

  14. Conclusions • Short-term supply factors and the catch-up to EU levels may play a role in relatively high inflation, as they do in other Baltic countries. • Demand pressures – compounded by structural factors – contribute to inflation inertia in Latvia. • Even if inflation is driven by short-term supply factors, there is a danger of second-round effects as evidenced by recent wage hikes.

  15. Possible Policy Responses • Slow the growth of domestic demand, mainly by cautious fiscal policy (save revenue overperformance and keep expenditure/GDP constant). • Keep wage growth in check to avoid a wage-price spiral. • Improve competition, including at the retail level.

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