Central bank: Government could calm fast price growth with budget policy

Stacks of euro bills.
Stacks of euro bills. Source: Siim Lõvi/ERR

Estonia's economy has recovered very well and has exceeded pre-crisis levels in most sectors, a recent economic forecast by the Bank of Estonia reads. There is increased price growth in Estonia, which could be calmed if the government would not increase the volume of expenditure in the coming years, the central bank warns.

Prolonged price growth would endanger peoples' purchasing power and the competitiveness of the export sector, which leads to more jobs and long-term wage growth.

"While the price growth pressure is higher for Estonian economy than the eurozone's average, the government holds the leading role in affecting Estonia's local price increases. The government and parliament can decide how much of a boost can be provided to the economy and prices through state budget expenses," said Bank of Estonia president Madis Müller.

The forecast states that Estonia's economy is set to grow 9.5 percent by the end of the year. The economy's total volume will clearly exceed pre-crisis levels after a drop of 3 percent last year, the central bank noted.

That has happened due to the strong growth in sectors that withstood the crisis well (information and communication, transport, construction, services), while sectors that suffered (accommodation and catering, entertainment, administrative and support services) have not reached pre-crisis volumes, the forecast reads.

"The economic structure has changed a lot during the crisis and part of the changes can turn out to be permanent since people employed in other sectors during the crisis might not return to their previous sectors," the central bank assessed.

The bank also estimates that companies will begin hiring more people to increase production volumes and unemployment will decrease to pre-crisis levels by 2023. Active labor market will maintain rapid wage growth this year and next year and there will likely be more mobility between jobs.

Many factors are causing Estonia's price increase. In the middle of this year, the increase in energy prices caused inflation to grow by 5 percent. If the price of energy does not grow any more, it will still affect inflation since the low comparison base of energy prices will withdraw itself from data in the upcoming year.

Prices are also affected by companies having a hard time increasing production to meet the heightened demand - in addition to labor shortages, production capacities have been almost fully utilized and it will take time to make investments necessary to increase production.

Disruptions in supply chains, material shortages and rising material costs will become global issues in the near future, which will also increase consumer prices. The central bank expects the factors behind the current rapid price growth to be temporary and price growth will slow down to 3.6 percent next year. At the same time, the 3 percent increase in prices is considerably faster than the tempo of Estonia's price increase over the last few years.

The bank notes that it would be reasonable to balance out the state budget by 2023 to help manage price growth, which would maintain peoples' purchasing power and the competitiveness of exporting companies.

In thanks to rapid economic growth, the Bank of Estonia stated that a balanced state budget could be achieved in 2023 without reducing government expenses. It would be enough to limit the growth of expenses. Reaching a balance is important for the Estonian economy to be prepared for any unexpected setbacks in the future.

"The state budget's volume increased very sharply due to support measures during the coronavirus crisis. From this already high level of expenditure, state expenses cannot grow too rapidly in the coming years without the gap between government revenue and expenses becoming too wide," Madis Müller said.


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Editor: Kristjan Kallaste

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