Each additional euro injected in the economy must be well targeted says Ülo Kaasik
Eesti Pank is forecasting that inflation in the Estonian economy this year will average above 10%, which is largely a consequence of the war in Ukraine causing commodities prices to rise higher. It is important under these circumstances that the choices made by the Estonian state to ease the negative impact of the war do not boost inflation further, said Deputy Governor of Eesti Pank Ülo Kaasik to a finance conference in Pärnu.
“Our economy was in a very good position when the war broke out”, he commented, noting that there were already signs then of overheating in the Estonian economy. GDP grew by more than 8% last year, there were labour shortages in the labour market, and wages were rising fast. The economy is expected to continue to grow fast at current prices this year, but as the rate of inflation will exceed that of growth, real growth in the economy will stop, and some decline is even expected. “This will however not be a decline that is caused by weak demand of the sort that the state should stimulate and support”, said Mr Kaasik.
The impact of the war is being particularly strongly felt in the Estonian economy through the inflation channel. The outbreak of the war caused prices for various commodities to rise sharply on global markets, with fuels leading the advance while prices also rose for industrial commodities and food. Problems with supply chains also worsened as alternatives needed to be found for several goods from Russia, Ukraine and Belarus. “We can see in consequence that inflation will remain higher for longer than was initially forecast, and we now expect it to be next year when inflation comes down”, said Mr Kaasik.
High inflation causes uncertainty. People find their purchasing power declines, companies find it harder to make plans, and confidence evaporates. Over the long term this can affect the potential for growth in the economy, as investments go unmade. Local upwards pressure on prices must also be considered, as wages in Estonia are forecast to rise by 7-8% a year in the years ahead.
When the government plans measures to compensate for high inflation and to alleviate the negative impact of the war, it should remember that those measures should not drive domestic inflation in Estonia even higher. Sticking to this this will help to maintain the competitiveness of Estonian companies. “The measures taken need to be targeted above all at those who are facing the greatest difficulties”, said Mr Kaasik. They could for example support businesses that have suffered most from markets disappearing because of the war, or the retraining of people who have lost their jobs for the same reason. When additional spending is planned in the budget it should first of all go to the additional emergency costs that the war has caused - for helping refugees and increasing Estonia’s defence and security capacity. “There is a risk that if the state tries to alleviate inflation impact too broadly, it will actually boost inflation further”, said Mr Kaasik.
Inflation rose in the euro area to 7.5% in March. The European Central Bank is ending the support measures launched during the pandemic and earlier to revive the economy. Markets expect that interest rates could start to rise in the euro area this year. This would make borrowing more expensive, and a rise in Euribor would start to affect loan servicing costs in Estonia as well.
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