Müller: Inflation a bad surprise, but we are chasing western Europe

Madis Müller.
Madis Müller. Source: Siim LõvI /ERR

Bank of Estonia governor Madis Müller told ERR that although the rapid inflation has been a bad surprise, the Estonian economy is growing and the country is approaching several Western European countries. The central bank forecasts that the average wage will grow to €2,000 in a few years.

Do you agree that the situation getting this bad was completely unexpected? Inflation is set to grow very fast in the fall and next year and rapid economic growth has decelerated, if not to say suspended. Was it a bad surprise?

Inflation being this rapid over the recent months was certainly a surprise. Inflation in Estonia was close to 9 percent in November - we have not seen numbers that high for a long time. For energy prices to grow this fast - and not just for a single moment - but for a few months, no one saw that coming. That is the main thing that has affected Estonian inflation.

I do not think we can say that we have done bad recently. The Estonian economy as a whole, if we look at the gross domestic product, is doing very well currently. The economy has clearly exited the crisis as a whole, although there are some exceptions by industries.

If we look at earlier Bank of Estonia economic forecasts, which we conducted before the coronavirus crisis, we are at a much better point now than we forecast in 2019. The situation is not bad for the economy, but if you look at growth indicators, they have been a little lower than we forecast.

Actual economic growth this year has been rapid, but there are several factors behind it, starting from the crisis bounce-back to second pillar pension money, which entered consumption temporarily. This all will decrease in the upcoming year and growth pace will certainly be slower than this year.

Could we reach a situation where the inflation in Estonia could exceed 10 percent for colder winter months?

We are not far from 10 percent now and it will largely depend on what energy prices do in the upcoming months. It is very hard for me to say what electricity or gas prices do, because that all depends on geopolitical developments. If prices increase even higher, it will certainly affect inflation data.

But it is hard to imagine that this energy price inflation continues and the inflation is set to fall next year. Inflation falling does not mean that prices will immediately fall - we are talking about growth being slower. It would make sense for energy prices to come down some, however.

We will more likely see price increases for food prices and raw materials on the world market, which is why wood can be pricier than this year. There is the danger that the longer this inflation, stemming from temporary factors, happens, the more it will carry over to the prices of products and services. We must see that our generally well-off economy's situation is not overheated any more, which would give prices another push.

How will our increasing price and wage levels affect Estonian competitiveness? Our production will turn too expensive, which will in turn affect our exports?

Wages and labor costs in Estonia have grown at a faster pace than in Western Europe and at our other competitors for some years now. This has led to Estonian companies having to reorganize their activities, certain companies are no longer competitive and new ones join the market and they can manage better in these conditions. As a whole, we can say that Estonian entrepreneurs may have even gained some market share.

Those gains also stem from energy and production prices being so low. But this rapid increase has finally come this fall and is likely to continue until next year?

Actually, all European countries are in a similar situation, where energy prices have gone up. It is not a unique issue in that sense. But the truth is is that we must be cautious. If there are factors exclusive to only us, which could increase our inflation, there is certainly the risk of Estonian companies' competitiveness taking a hit and this will end with a sudden stop for wage increases.

We have no clear signs of it today, but we must certainly be guarded if the price inflation to remain high for some time. This could lead to a spiral, in which the labor market is so tense that companies no longer find employees and there is too much tension for wage increases. You have people calling for more money on one side to keep up their living standards and companies do not have as many options if there are no alternatives on the labor market. In that case, there is the danger of wages going up too fast, which is why prices need to be increased since costs have increased. An important thing is for us to not go over that limit where competitiveness takes a hit.

If we look at Bank of Estonia forecasts for the upcoming years, we can see that employees are in a dominant position on the labor market and there are labor shortages in many sectors. Wage increases in the coming years will likely continue to be fast. Price inflation, which is currently at a high level, should level off in time. We know there are many temporary factors, which have increased prices, but the average income growth is still higher than inflation.

You predict that the average wage could soar to €2,000 in a few years? Will the Estonian economy handle such high wages?

We care currently bold in our forecasts and say that it will and this is essentially a continuation of our current trends, where Estonian entrepreneurs have adapted well in recent years and have been able to maintain their competitiveness in a situation, where labor costs are growing. But this also means that some structural changes must take place in the economy.

It is not possible to continue raising wages in all sectors. Automatization will have to be used more in production. Each sector must find ways to make operations more effective.

The second pillar pension payout reform took place right in the middle of increased price inflation. Looking back at it now: how did it go? Could these people have received their money a little earlier or what was the result?

It is honestly hard for me to make a comment on if people should have withdrawn their pension funds either earlier or later, because I considered the entire amendment a bad idea. This reform not taking place whatsoever would have made it better.

What we can say about the timing is that people received their pension savings and began using it them in a situation where Estonia's economy was in a good situation. The timing was not good in the sense of giving people additional momentum at a moment when people had already saved up more than usual during the crisis, when expenses just could not take place. This perhaps amplified the temporary consumption party in the second half of the year, which may cause the illusion of it being a permanent situation, which it actually is not.

Rapid price increases and continuing economic growth means the state's coffers are filling up nicely. Why do you forecast that there will still be a deficit state budget?

The state's coffers fill up as a function of economic growth, which will die off somewhat in the coming year. Price inflation is somewhat faster and will compensate for it, but the level of expenses has already been high these last few years, so the price increases do not play much of a role in terms of budget deficit in our forecasts.

We have actually gotten through the crisis rather well compared to other European countries. Only Ireland has seen faster economic growth compared to the end of 2019. Are we now wealthier than Spain per person? Is our GDP greater?

It is always smart to check this data before responding. I think we may be level with Spain, but only when it comes to gross domestic product. The sprint in recent years has helped us and we are just a tick ahead.

This means we are actually in another league now? Essentially, Estonia has taken a rather large step in chasing Western Europe?

We must admit that everyone is not doing as well. The development of the Estonian economy has been in a great situation for a few years and many southern countries, European countries, have not grown as well. We are truly approaching those countries in terms of average wealth, which we could not have predicted a decade ago.


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Editor: Kristjan Kallaste

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