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Anett Balázs
Anett Balázs
Mr.Polis
Economics IB2 HL

Inflation in Latvia: Causes, Consequences and the Governmental Response

Inflation is defined as a persistent increase in the average price level in the economy, usually measured through the calculation of a consumer price index.

Causes of inflation in Latvia

• Exchange rate Developments: “Latvia has a fixed exchange rate, with the currency pegged to the Euro, and the government does not want this to change. If this nominal rate of exchange stays fixed (at one Euro for 0.7 Lats), then the only way to lower the value of the currency internationally is to do so in “real terms.” This means pushing wages and prices down.”

• “Changes in administrative prices and widespread expectations of higher prices due to EU accession or an unfavorable exchange rate developments. (Lat is pegged to the Euro).  Result: overheating in the labor market

• Rise in production costs, which leads to an increase in the price of the final product: “Latvian production can become more internationally competitive by lowering prices and wages internally, while keeping the currency’s international exchange rate fixed.”

• Inflation can also be caused by international lending and national debts: “This includes fiscal policy, as noted above: as part of its agreement for a loan from the IMF, the government has agreed to budget cuts and tax hikes amounting to 6.5 percent of GDP in 2010. As the Fund acknowledges, this will further weaken the economy in 2010.”

• Inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel: “High rates of inflation, averaging 13.2 percent between 2006 and 2008, have come down since mid-2008 when increases in oil and food prices came to an end.”

Consequences:

The consequences that could be true about Latvia are the following:
• Exports would tend to decrease and imports increase as the relative prices
of domestic goods began to exceed those of foreign goods Due to high inflation and selling their own goods at a higher price and the foreign goods are a lower price
• Unemployment increases People left the country because there either wasn’t job opportunity or they were fired
• Savers probably suffered since the inflation was high and people could afford less and the savers had to spend most of their money if they wanted to have a good living.

Government Response:

• The Latvian government came up with an anti- inflation plan, which are the following:

Budget policy, real estate and measures to dampen the credit boom- “are described as providing for short term and medium term implemention”
 Labor market, productivity, energy efficiency and increase competition – “planned to bear fruits in medium and long term”

• Also they have been planning on spending cuts: “For the 2010 budget the Latvian parliament has passed tax increases and spending cuts of around 700m euros (£610m).”

(http://news.bbc.co.uk/2/hi/8496925.stm )

http://www.globalresearch.ca/index.php?context=va&aid=17627

http://www.biceps.org/files/OccasionalPaper2.pdf

http://www.bbn.ee/Print.aspx?PublicationId=def97981-ecbb-4096-8b2a-9207c3fe518a

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