Inflation in Latvia: Causes, Consequences and the Government response.
Latvia joined EU in 2004.
Causes for inflation:
I specifically mentioned joining EU in previous paragraph, because as you might notice it from the graphs (image 1 and image 2), inflation increase drastically since we joined the EU. (Countries may not join EU if they have a higher than about 1.5% inflation, because its always expected to have a greater increase in inflation once you join EU.) However this obviously wasn't the only reason for inflation. My previous point is supported by another economist: "These increases are well explained by e.g. exchange rate developments (appreciation of the euro, thus depreciation of the lat, thus higher import prices), changes in administrative prices and, for the latter, widespread expectations of higher prices due to EU accession (see e.g. Benkovskis and Paula (2007) for a comprehensive survey) which seemingly made it easy for firms to charge higher prices.” (Alf Vanags and Morten Hansen,pg 5) „It is the result of overheating in the labor market as well as of higher inflation expectations. Latvia today is a country with substantial inflation and people know this and factor it in to wage demands, which in turn add to the production costs of firms and end up in higher prices.” (Alf Vanags and Morten Hansen,pg 5)
To simply put what Alf and Morten says is that the companies see that people can afford more because the wages are higher, therefore they increase the prices of goods. (People request higher wages, because they see that prices increase, and prices increased due to many reasons, one of them ironically is that producers saw that wages increased, but also taxes and etc.) Also another reason, is that banks were giving out loans to basically anyone that was at least the age of 18. (as a Latvian I know that it was very simple to get a loan during these times). This meant that producers increased their prices even higher, because people could pay for it. Somehow the Latvian mentality created this problem, because a lot of Latvians believed that they can afford this loan, that times will continue being good. (One of the reasons why Latvia has the highest luxury car to people ratio in European Union.)
Consequences for inflation inflation in Latvia:
Loss of purchasing power, this means that the money you have right now won't be worth as much as next month, because of the inflation. This affected savings, because people didn't want to save because their money was losing value (if it was kept in Lats).Another consequence was imports and exports and this was due to the fact that other countries would import goods to Latvia because there was the opportunity to gain profits due to this high inflation (Lithuanian milk and etc), but Latvian producers didn't want to export because they could gain profit here. Most economies can't survive, if they don't export.
After reading the document composed by Alf Vanags and Morten Hansen, I can agree with them that Latvia had a inflationary spiral. (Prices increase because people have higher wages.)
Government started a anti-inflationary plan, but they never really could control the inflation and till the collapse of Parex Banka, it was going on and on. Obviously it got better as the people of Latvia realized that this is getting a bit out of hand, but as a Latvian I didn't see any good response from the government, or it would be more appropriate to say that, I didn't see a response that worked. Latvias inflation finally reduced because of the economic crises worldwide.
Bibliography: Alf Vanags and Morten Hansen. Biceps