The Discussion Paper Series contains analysis by the employees of the Bank of Latvia and conclusions set forth. Materials are published to bring the issues vital for Latvia's economic development up for public discussion. Some Papers are used during expert discussions organised by the Bank of Latvia. This series is addressed to a wider audience in Latvia and abroad.

3/2015 Evaluation of Latvia's Re-Exports Using Firm-Level Data
Konstantīns Beņkovskis, Santa Bērziņa, Līva Zorgenfreija

Discussion paper

We use an anonymised firm-level trade database provided by the CSB to evaluate Latvia's re-exports. We obtain estimates of re-export flows and the corresponding re-export mark-ups by solving a linear maximisation problem for each firm-product pair. We find that the share of re-export flows in the total merchandise exports and imports is significant and follows an increasing trend. The share of re-exports is especially important in product groups, such as transport vehicles, plastics, mineral products, as well as machinery and electrical equipment. The majority of re-export flows is directed to Latvia's closest neighbours Lithuania and Estonia, suggesting that the country serves as a sort of a regional transport hub. We also find that the average re-export mark-ups were sizeable allowing us to conclude that re-export operations may also provide an important contribution to Latvia's GDP.

Keywords: re-exports, firm-level data, Latvia, simplex
JEL codes: D22, F14

2/2015 Natural and Cyclical Unemployment in Latvia: New Insights from the Beveridge Curve Model
Oļegs Krasnopjorovs

Discussion paper

Whether current unemployment in Latvia is mostly structural or cyclical recently provoked an intense debate among policy makers and academic researchers. This paper follows the method proposed by Barlevy (2011) to estimate natural and cyclical components of unemployment from the Beveridge curve model. It finds that at the end of 2014 unemployment in Latvia was quite similar to its natural rate. Zero cyclical component of unemployment suggests that aggregate-demand-stimulating policies would not bring unemployment down without creating inflationary pressures and competitiveness loss and, therefore, are not a preferred option. Instead, raising matching efficiency between the unemployed and vacancies would decrease natural unemployment from its current high of about 11%. Moreover, it was found that the lowest matching efficiency between the unemployed and vacancies is present among workers (compared to managers and professionals) and typical for Latgale region. This might reflect significant structural problems rather than low business cycle synchronisation with the other occupational groups and regions.

Key wordsunemployment, vacancies, Beveridge curve, cyclical unemployment, natural unemployment, structural unemployment
JEL codes: J63, J64, E24, E60

1/2015 Cobweb diagram as a tool for assessing changes in the most important financial stability risks
Olga Lielkalne, Nadežda Siņenko

Discussion paper

The Discussion Paper analyses a risk cobweb diagram employed as an additional analytical tool for monitoring and assessing financial stability risks in Latvia. The aim of the risk cobweb diagram is to depict the most important financial stability risks across specified risk categories and the direction of their changes in a single chart. The risk cobweb diagram and the dynamics of the index corresponding to each risk category and its components make it possible to visualise and analyse development of external and domestic macrofinancial risks and vulnerability changes of the banking sector in Latvia by assessing the credit risk of non-financial corporations and households, profitability and solvency risks of credit institutions, as well as funding and liquidity risks. The Discussion Paper gives the overview of the use of the risk cobweb diagram and its methodology in other countries. It also outlines the process of the development of such a diagram in Latvia and describes selected risk categories and indicators. The Discussion Paper concludes that the results of the back-testing of the risk cobweb diagram have been adequate. In 2008 and 2009, the risk category assessments of the risk cobweb diagram signalled threats to financial stability, while risk category indices and their components allowed the identification of the areas where accumulation and materialisation of financial stability risks occurred.

Keywords: financial stability, risk cobweb diagram, risk categories, monitoring of financial system stability, assessment of financial system stability
JEL codes: E32, E44, E58, G10

3/2014 Forecasting Natural Population Change: the Case of Latvia
Aleksejs Meļihovs

Discussion paper

The paper is devoted to the natural population change forecast in Latvia for the time horizon until 2030. The motivation for this paper is twofold. First, population ageing is an obvious problem for the whole EU with a tendency to worsen in the future. However, for EU11 countries, including Latvia, the situation is more challenging. Second, historical population data have been revised based on the results of the last population census that took place in Latvia in 2011. This data correction could help to make a clearer vision of future tendencies in demographic indicators.
The approach developed in 2007 by Hyndman and Ullah is used for the natural population change forecasting. This approach combines functional data analysis and principal components decomposition. Although the applied approach is a technical one, it is useful for understanding what a policy maker could deal with in 15–20 years from now in the case of no-policy-change and no-population-habits-change scenario. By understanding this issue, it could be easier for the policy makers to make right decisions with a long-run perspective helping population and economy to be prepared well for the problems associated with population ageing that will accumulate in the future.
The model is used to forecast mortality rate schedules separately for males and females as well as fertility rate schedules. The main findings of the paper are the following. The total period fertility rate is forecasted to increase to about 1.6 by 2030. Life expectancy at birth is projected to increase for males and females by 4 and 3.4 years respectively. Nevertheless, the natural population decrease in 19 years will reach 200 thousand including the decrease of about 190 thousand in population aged 20–64, while the old-age dependency ratio will increase to 36.5%.

Keywords: functional approach, fertility rates, mortality rates, population forecasting
JEL codes: F12, F15, F51

2/2014 Assessing the Extent of EU–Russia Trade Integration in the Presence of Global Value Chains
Konstantīns Beņkovskis, Jūlija Pastušenko, Julia Wörz

Discussion paper

The present paper analyses trade linkages between EU Member States and Russia taking into account the indirect trade links through global value chains based on data for 2011 from the World Input-Output Database combined with gross flows between Russia and individual EU countries. We base our conclusions on three indicators: gross exports in final use, value added in final use and value added in output. The latter two novel indicators are able to capture direct and indirect links jointly by allocating the full amount of Russia's value added in the EU's final domestic use and output (and vice versa: the EU's value added in Russia's final domestic use and output). In terms of direct export shares, Russia represents the EU's fourth largest trade partner, while the EU is Russia's largest trade partner. The Russian economy is also considerably more dependent on European value added in terms of both final use and producing output than vice versa. However, the degree of integration varies greatly across the EU Member States. For example, the Baltic States are notably more dependent on Russia's value added than vice versa. Moreover, certain economic sectors in the EU are strongly dependent on Russian inputs, such as the energy sector, utilities and air transport.

Keywords: trade integration, global value chains, Russia, European Union
JEL codes: J11, C53, C14, C32, O11, O52

1/2014 Survey-Based Assessment of Household Borrowers' Financial Vulnerability
Mikus Āriņš, Nadežda Siņenko, Laura Laube

Discussion paper

This Discussion Paper is an attempt to provide insight into the debt servicing capacity of Latvian households and its sustainability under the impact of different macroeconomic shocks based on individual household data obtained by surveying households with at least one loan for house purchase. To assess the financial situation of these households, changes in the household solvency are modelled under the impact of different economic shocks (shrinking employment income, rising interest rates, loss of jobs) and the obtained results are generalised to the aggregate portfolio of loans granted by Latvian credit institutions to households for house purchase. The results obtained lead to a conclusion that following the financial crisis household solvency is still fragile and possible negative shocks might contribute to higher potential losses of credit institutions. At the same time possible losses to lenders arising from such adverse shocks might be lower than two years ago since the value of collateral has increased with real estate prices moving up, while outstanding loans granted for house purchase have declined.

Keywords: analysis of household solvency, stress tests, sensitivity analysis, financial margin, macroeconomic shock scenario, microdata
JEL codes: C15, C35, D14, E21, G21

1/2012 Latvian Financial Stress Index
Nadežda Siņenko, Deniss Titarenko, Mikus Āriņš

Discussion paper

The objective of this Discussion Paper is to develop a methodology for Latvian FSI. To this effect, the particular methodologies widely used in international practice for composite indicators applied in financial stability monitoring and the experience of selected countries were examined. The authors analyse the nature of financial stress and the related symptoms and offer their interpretation of the financial stress concept. The Paper provides the rationale behind the selection of the individual indicators (components) comprised in the FSI, evaluates various options for aggregating the FSI components as well as features a comparison between the methodology applied for the Latvian FSI and the practice pursued in other countries. The main conclusion presented in the Discussion Paper is that the dynamics of the FSI developed on the basis of the Bank of Latvia's methodology is quite an accurate measure of changes in the Latvian financial system's stress levels. It signals periods of elevated stress as well as periods of an excessively vigorous and imbalanced development of the financial system. The Bank of Latvia has been using the FSI as one of the elements of Latvia's financial system stability monitoring framework since 2009.

Keywords: financial stability, financial stress, financial stress index, financial system stability monitoring
JEL codes: G01, G10, G20, E44, E58

1/2011 The Convergence Processes in Europe and Latvia
Aleksejs Meļihovs, Igors Kasjanovs

Discussion paper

This paper, attempting to tackle separately real and structural convergence, is an in-depth study of the convergence processes in Latvia and Europe. Latvia's structural convergence towards both the EU and other neighbouring (Baltic) countries is estimated using the Krugman index. Real convergence processes in the EU, distinguishing between σ convergence and β convergence, are likewise studied. In addition, cluster analysis with grouping European countries by their structural features is conducted.
In this study, the current β convergence and σ convergence processes within the EU are identified, yet an in-depth study disclosed that it was mostly the EU12 countries that were the convergence process drivers, with convergence at the regional level well behind that at the national level. The convergence among the EU Member States primarily depended on the wealthier regions of countries becoming richer (characteristic of EU12 in particular), with the process proceeding at a faster pace in relatively poorer countries. This suggests that within a country the discrepancies between rich and poor regions intensify over time. That leads to a conclusion that the European regional policy aimed at decreasing regional income heterogeneity did not prove efficient in the reference period.
Structural convergence in Latvia was mainly observed in 2008 and 2009, i.e. the years of real divergence enhanced by the onset of the crisis. Structural convergence in the breakdown of gross value added was mainly driven by the fluctuations of the value added ratio of trade, tourism and transport, manufacturing and construction sector.
The conducted cluster analysis demonstrates that over time European countries have become more homogenous or mutually similar in terms of economic structure. A particular focus on the specific economic characteristics of countries leads to a different conclusion: the countries in Europe agglomerated into several specific groups, thus clearly outlining the different drivers of growth in the post-crisis period.

Keywords: Latvia, the EU, structural convergence, real convergence, specialisation, cluster analysis
JEL codes: C20, C50, F15, E13, E60

1/2010 Price Setting Behaviour in Latvia: Descriptive Evidence from CPI Microdata
Konstantins Benkovskis, Krista Kalnberzina, Ludmila Fadejeva

Discussion paper

The question of price stickiness remains one of the most important in macroeconomics, as price flexibility partly determines how long it takes for inflation and real economic variables to return to their potential levels after a shock. To get a better understanding of price change frequency and size, the empirical work on price stickiness based on microdata from surveys on prices of individual products from individual outlets is needed. The main goal of this study is to provide descriptive evidence on the degree of nominal rigidity of consumer prices in Latvia at aggregate and disaggregate levels. To achieve this goal, we use the micro database on consumer prices provided by the CSB. The main finding of the paper is that during 2003-2009 Latvia's consumer prices were flexible. The average duration of a price spell was 3.5 months, and every month on average 28.7% of consumer prices were changed.

Keywords: price setting behaviour, Latvia's consumer prices, frequency of price change, duration, size of price change, sales, time-dependent pricing, state-dependent pricing
JEL codes: D40, E31

1/2009 Savings in Latvia
Agnese Bicevska, Aleksejs Melihovs, Krista Kalnberzina

Discussion paper

A high saving rate is the foundation of a sustainable national social and economic policy. Nevertheless, boosting saving is not an end in itself. The process of making savings should be analysed taking into account several related aspects. This paper aims at conducting a detailed and comprehensive analysis of saving behaviour in Latvia and its estimation in the global context. Household saving behaviour and saving habits are in a particular focus and are examined econometrically using a unique source of Latvia's micro data, i.e. household budget surveys.

Keywords:savings, household saving habits, micro data, cross-section model.
JEL codes: C21, D12, D14, E21, O16