Latvia’s Inflation: The high inflation in Latvia was caused by a few different actions or events that took place. "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.” ( Vanags & Hansen, 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.” ( Vanags & Hansen, 5 ) This then creates that inflation spiral where the employee knows that there is inflation and because of this, he asks for an increase in salaries in order to maintain his purchasing power. The stores then realize the same thing, that consumers still purchase their products meaning that they are able to raise them to the inflationary measures, in order to continue making profits.
From here the causes of the high inflation can then be assessed again to the inflationary spiral and the growing prices of production. This means that as the price of production goes higher, so does the price for the product, resulting in direct inflation.
• Loss of Purchasing Power:. This can then be related back to Latvia very easily, for this is when the consumers money in Latvia starts becoming worth less, resulting in a loss of purchasing power, which can only be met if the employees of the consumers raise their salaries to meet the inflation.
• Effect on Savings:. This can then be related back to Latvia in the way that the people who have put their money in the bank, will start to lose the value of the money, meaning that once again there is something that either the bank or in most cases the government has to do in order to fix this flaw.
• Effect on international competitiveness: This is very important in relating to Latvia, because now international companies looking to trade in Latvia, will look elsewhere into nations with less inflation because high inflation in a nation usually means that the economy of the country is not as stable as it should be. Also the exports from Latvia will be less competitive due to the high inflation rate.
Analyzing the Latvian economy one comes across the following issues with the economy linked to inflation. First of all, in the report made by Alf Vanags and Morten Hansen it can be agreed upon that there indeed is a inflationary spiral taking place where prices keep moving up, following with consumer income rising accordingly.
From here it can then be seen that as price increases so does output, and it literally is a repeating circle. This is a good example of the inflationary spiral.
A few things that the government could do in order to control inflation is that they could apply fiscal policy or in other words decreasing govt. spending and increasing taxes. Because both factors influence spending, since there is less money around. This will result in consumers spending less, which will result in a fall in demand. A fall in demand will then result in a fall in prices
Alfs Vanags, Morten Hansen. "Inflation in Latvia: causes, prospects and consequences." A BICEPS Report (2007): 23.
P.S The word count says its 620 but that includes the words in the graphs and the bibliography, so I'm still under the word limit...