Economists: Inflation must not take root in Latvia

Central banks are committed to raising interest rates in order to fight inflation. In a discussion held by the Latvian central bank (Bank of Latvia) on Monday, October 17, experts will look at how this decision will affect households and businesses, and whether the Latvian economy can withstand a combination of high inflation and interest rate rises. The expert discussion is streamed live on LSM, and you can watch it below this story.

With interest rate increases, central banks are committed to fighting inflation, which exceeds 20% in Latvia and other Baltic States. Kārlis Vilerts, head of the monetary policy research department of the Bank of Latvia, stressed that this is a hard pill to swallow, but it is needed to keep inflation from rooting.

“One thing is to live with inflation for a short period of time, knowing that very soon we will return to low inflation, at 2%, as we have seen in the last 10 years. A different story, if inflation is to stay. Then there is the risk that inflation will take root, it will be priced into wages, but employers will be forced to finance it by raising prices for goods and services, so inflation will be driving itself forward,” explained Vilerts.

Higher interest rates are a way to cool and brake inflation a little. Vilerts said that inflation is not currently caused by the overheating of the economy, but by global developments – rising energy resources and food prices, problems with supply chains. Higher interest rates will not solve these problems directly.

“Consequently, it is naive to expect inflation to brake immediately. What higher interest rates will do is not allow that, when the energy crisis is over, inflation will be here to stay. In this way, high interest rates do their job. It is a sign that central banks are aware of the seriousness of the inflation problem and are doing all they need to return inflation to the 2% target as soon as possible."

Dainis Gašpuitis, economist at SEB Bank, said that economic growth is currently slowing down and problems are only exacerbating, and the highest point is still ahead.

"And in such circumstances, raising interest rates, which further complicates this situation, is not really optimistic [..] and, of course, increases costs for both households and businesses. The question is: What else are the alternatives? At present, the processes that drive inflation in Europe are basically gas prices and developments in Ukraine. And it's clear that central banks do not have the tools and levers," said Gašpuitis.

Higher interest rates mean that for businesses and households, monthly credit payments will rise, and there may be some customers who will find it difficult to cope with cost rises. “Of course, if both utilities and food prices rise, then credit payment can be a very difficult challenge.”

The Chairman of the Board of the Latvian Chamber of Commerce and Industry, Jānis Endziņš, said that this situation is not easy for companies, because it will create more expensive credit servicing, and the market situation is also deteriorating in Latvia and in export markets. According to Endziņš, recession is expected in the near future.

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