On Tuesday, the Bank of Estonia presented its economic forecast. Müller told ERR that inflation has been the biggest problem over the last few years. In the long term, this raises questions about how Estonia can maintain its competitiveness.

"The fact that we've come down from nearly 20 percent inflation to around 3 or 4 percent is a significant success story, and it certainly provides some relief to the people of Estonia. This is especially true given that for some time now, the average income growth has clearly outpaced inflation. In other words, people's purchasing power and standard of living have, on average, visibly improved in economic terms over the past two years," he said.

The forecast says inflation will be between 3.5 to 4 percent over the next two years due to tax rises. Müller said they are necessary.

"There is also a long-term connection between public finances and inflation. If the state and government were to continuously boost the economy with borrowed money — essentially spending more than they have — then by constantly injecting additional loan funds into the economy, this would, in the long run, accelerate inflation," he explained.

The governor said putting Estonia's finances on a better path is important from a longterm perspective.

Müller stressed that even after the tax increase and cut plans, the state's expenses and revenues will not be balanced. The state will still be skirting the European Union's 3 percent budget deficit limit. This means Estonia spends around €110 for every €100 it receives in taxes and other revenues. Therefore, the state is not being overly conservative in its financial planning, he said.

"In my view, the efforts have indeed been made in the right direction, as the previous trajectory of the budget deficit was clearly unsustainable," Müller added.

When asked if higher taxes or cuts are preferable to put public finances in order, he said businesses would prefer lower taxes. This could increase investment in the country. But, at the same time, society has high expectations for public services.

"I believe it is always important to look for areas where cuts can be made, but I also understand that it's relatively easy to speak abstractly about reducing spending or eliminating certain services. It is much more difficult, however, when it comes to actually deciding which specific service to discontinue or where exactly to make cost savings," said Müller, but added that there is definitely room to make cuts.

The governor said it is expected that the government has tried to find a middle way, for example, raising taxes and making cuts at the same time. But the choices made are political decisions and the bank does not want to interfere.

The so-called temporary defense tax will end in 2028, and will likely create a significant hole. Müller said he has no idea how the state plans to fill it.

"Certainly, this presents a new decision point, which will depend on how the economy and the state's expenditures and revenues have developed by that time. It is, of course, difficult to make very precise forecasts so far in advance," he said.

As the latest forecast ends in 2026, Müller said it is hard to see beyond that, but it is quite likely the debate about higher taxes or cuts will return.

"It generally seems to me a good practice for the state's permanent expenditures to be covered by stable revenues, including from taxes. Looking ahead to 2028, particularly when assessing the growth of defense spending, one part of the question is how much of that increase is truly temporary and how much is not," brought Müller out. "I think we will have a clearer idea in the near future whether it's possible to scale back these temporary investments in defense capabilities, once they have been made. This could provide some relief to the state budget in a few years' time."

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