“The Pros and Cons of Deflation: Impact on Prices, Wages, and the Economy in Latvia”

In many cases, the high profit levels maintained during high inflation are less and less in line with the current market situation, because, understandably, the purchasing power of a rather large part of society is running out more and more. Although, unlike the neighboring countries, the economy has still shown growth, the situation in terms of economic sectors is very different, from solid growth to significant declines. Thus, if we look at the overall situation in the financial markets, including commodity exchanges, economic trends and the central bank’s monetary policy oriented towards the increase in loan interest rates, price increases should subside and we can rather talk about a decrease in the cost of living.

Not everyone will win

It is true that this tendency towards a price slowdown or even a fall may not promise a better life especially for everyone. It must be understood that if the prices fall, then someone is forced to sell something cheaper than before at its expense, thereby losing revenue. The question is whether the company managed to secure adequate financial reserves during the previous price jump, because at the moment we cannot rule out that relatively soon, perhaps even within the next year, the healthy downward correction of prices does not develop into a thorough deflation. In this case, the benefits of the rank-and-file worker may also be quite short-lived.

Last year, although it did not keep up with inflation, both the average and median wages, which describe the income of an average worker, increased in Latvia. If the hoped-for small price correction turns into a more prolonged and massive deflationary period, wage growth may also become a thing of the past. One can, of course, hope that the citizen will gain at the expense of a decrease in prices, but there is a very high probability that this may not happen. This is due to the fact that during the deflation the demand has dropped significantly, the implementation of new investment projects has stopped, and therefore there is also less demand for workers in the labor market. The welfare of the average or low-paid worker may therefore suffer even more than during the current hyperinflation.

An even worse situation can develop if companies are unable to meet their obligations due to the fall in revenues caused by deflation, which can be followed by an increase in the number of bankruptcies both at the level of companies and households. This is a critical scenario that we may reach in the next year or two. In terms of immediate and already existing things, if along with the prices the costs also decrease, then in theory the economic equilibrium should not disappear as well. However, the main problem during deflation is that price changes are not balanced. A good example is the fall in milk prices at the end of winter, when the producer was forced to sell cheaper, but at the same time costs remained high, thus threatening the financial existence of companies. And if the business environment drastically deteriorates, the workers also have no reason to hope for a better life, rather the opposite. But for now, the price trends are at least apparently better for the buyers than the sellers.

The joys of energy costs

Although there is no shortage of unpleasant surprises regarding the direction of prices and potential prosperity, there is also positive news. Its basis comes from the energy sector, especially when it comes to oil and gas prices. The predictions made earlier in the “Independent” column that the price of oil would show a willingness to fall, thus reaching new pre-war lows, have come true. At the close of the exchange on May 3, one barrel of Brent crude oil in the North Sea cost $72.33, the lowest level since September 2021 compared to the period before the war. Naturally, this has led to a noticeable drop in fuel prices in Latvia as well. Also pleasing are the changes in gas prices, which are getting closer to the level that was before the “big” price level started. The current EUR 36-37 per megawatt-hour of natural gas is about nine times lower than at its peak last August and corresponds to the price level of July 2021, well before the start of full-scale hostilities in Ukraine. We can be pleased that the world has come to terms with the negatives of Russia’s lack of raw materials, and the fall in price will significantly reduce the neighboring country’s income in order to finance the continuation of the war. For us, this means a drop in heating and hot water tariffs, as well as a reasonable hope that we will do without a similar jump in electricity prices as last August. Respectively, we have entered a phase when we begin to experience a decrease in various cost levels and foreign trade prices will be favorable for filling the wallets of the majority of Latvian society, rather than emptying them, as was the case last year.

Waiting for cheaper food

As the increase in the cost of living in the world recedes, changes are also visible in foreign trade prices, whose previous growth rate is shrinking in both the export and import sections. Also, looking at shorter timeframes, such as one month, can also see price declines that could potentially develop into an overall trend, and eventually price declines can also occur on an annual basis.

The largest item of budget expenditure of Latvian citizens is related to food. Here, too, we see that the price growth rate decreases every month compared to the corresponding month in the previous year. For example, in February of this year, compared to the corresponding month in the previous year, the prices of food imports had increased by 13.1% in total. For comparison, half a year earlier, in August last year, this growth rate reached 20.6%. This means that the increase in price will dry up and it will also reach the wallet of the ordinary buyer. There are already more and more food products whose prices are falling. True, for the time being it can basically be attributed to dairy products and potatoes. Regarding the latter, it should be added that when the stocks of the previous harvest run out and the market is increasingly taken over by new potatoes, prices may experience a seasonal increase until the new harvest.

On the other hand, in the near future, the prices of meat, as well as various cereal products, could fall. True, not everyone. For example, rice prices could rise due to lower harvests and various logistical problems, including Russia’s war in Ukraine.