To analyse inflation in Lithuania and determine inflation trends in the long run, the paper identifies long-term factors, namely the Eurosystem’s monetary policy and economic convergence. The main objective of the Eurosystem is to maintain price stability, defined as annual inflation rates below, but close to, 2% over the medium term. However, due to economic convergence, inflation rates of Central and Eastern European (CEE) countries can be around 1 to 3 percentage points higher than, for example, those of the older EU Member States. This is influenced by the participation in the EU single market, which promotes equalisation of prices and wages in the EU, and the fact that less developed countries of the EU exhibit relatively more rapid economic growth. The latter determines the convergence of the CEE countries’ income levels with the income levels of the more developed EU countries, and adds further pressure on inflation.
Lithuania’s inflation dynamics over the analysed period were also underpinned by various factors that caused inflationary fluctuations in the short and medium period, for example, domestic and foreign economic activity, international commodity prices, and administrative decisions. All these factors boosted inflation in 2017. Growth of food and beverage prices in 2013–2017 amounted to around 2.2% on average, reaching 5.5% in 2017. This increase was driven not only by the growth of food commodity prices, but also by a large increase of excise duties on alcoholic beverages. Service price growth in 2013–2017 reached around 3% on average, whereas in 2017 it accelerated to 5.5%. More rapid growth in prices of services in 2017 can be explained by the prevailing tensions in the labour market: a shortage of labour force, which has put pressure on wages, and a noticeable rise in the minimum monthly wage. Although the long-term growth rate of non-energy industrial goods has been close to 0, recent improvements in the international environment and rapid growth of unit labour costs have led to an increase in corresponding prices. Finally, the development of oil prices has had an indirect effect on the evolution of the prices of all inflation components in both the short and the medium term.
Countercyclical fiscal policies might improve the management of the economic cycle and inflation. Given that all euro area countries are under the Eurosystem’s monetary policy framework, a sustained fiscal policy would help to minimise inflationary deviations from the long-term trend of domestic economic factors. In terms of fiscal policies, the economy should not be further stimulated during an economic upturn (for example, through tax cuts or cost increases); government revenue surplus collected during cyclical upturn should be set aside in case of a downturn, thus preserving the volume of domestic demand.
When inflation fluctuations are disadvantageous to consumers, i.e. when revenue is growing at a slower or similar pace as prices, the purchasing power of the lowest–income households should be ensured. For the low–income citizens, economic benefits brought by growing economy can be insufficient or overdue. Therefore, the purchasing power of consumers with the lowest income can be maintained through structural reforms, for example, a thorough tax system reform. With such a reform, the share of GDP reallocated should be increased. Also, in order to increase GDP reallocation, significant changes in the tax system should not be carried out in isolation, i.e. restructuring of the pension system should come hand in hand.
The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.
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