Inflation in Latvia

Trond-Arne Borgersen and Roswitha M. King

Eastern European Economics, 2011, vol. 49, issue 3, 26-53

Abstract: This paper applies and extends the Scandinavian model of inflation for analyzing determinants of inflation in Latvia during the period 1996-2007. Until the outbreak of the financial crisis in 2007, high inflation was a persistent problem for advocates of Latvian participation in the Euro collaboration. By allowing for transitional effects and separating the impact of nominal and real factors on inflation, where real factors are related to the structural shifts at the heart of transition economies, we render the inflation history more understandable. We show that the effects accompanying real factors constitute the key component of overall inflation over the twelve-year period of observation, keeping nonstructural inflation below the Maastricht criteria for most of the period. The real contribution of real factors to inflation provides Latvia with better prospects for future growth and higher standards of living, and hence should be less worrisome than the nominal contribution. Still, when it comes to compliance with the Maastricht criteria, the Economic and Monetary Union makes no distinction between the two, complicating convergence for transition economies.

Date: 2011
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