2005

5/2005 Cyclically Adjusted Balance of Latvia's General Government Consolidated Budget
( 1,49 MB)
Sigita Grundiza, Dainis Stikuts, Olegs Tkacevs

Abstract
This study estimates cyclically adjusted balances of Latvia's general government consolidated budget using methodologies of the ESCB and OECD and assesses the consistency of the implemented fiscal policy with the EU fiscal policy framework. During the period of rapid economic growth the Latvian government pursued fiscal expansion instead of ensuring budgetary consolidation in cyclically adjusted terms. Fiscal policy of the Latvian government has been inconsistent with the requirements of the Stability and Growth Pact and has exerted an additional pressure on consumer prices and the current account.

Key words: cyclically adjusted budget balance, Stability and Growth Pact, pro-cyclical fiscal policy, budgetary elasticity

JEL classification codes: E62, H62
4/2005 Short-Term Forecasting of Economic Development in Latvia Using Business and Consumer Survey Data ( 2,56 MB)
Aleksejs Melihovs, Svetlana Rusakova

Abstract
At any stage of an economic cycle, policy makers and production managers are to make decisions how to benefit from an economic upswing most, or how to mitigate the adverse effects of an economic downturn. An early evaluation of economic development trends in a country will lead to a more favourable translation of policy decisions into economic processes at both microeconomic and macroeconomic levels. An assessment of economic business cycles often involves business and consumer survey results as evidenced, for instance, by rich practices of the EU and other world countries. This paper examines the usefulness of indicators from business and consumer surveys in the short-term forecasting of Latvia's economic development.

Key words: business and consumer surveys, economic development, short-term forecasting

JEL classification codes: C22, C53, E32
3/2005 Assessment of Labour Market Elasticity in Latvia ( 3,87 MB)
Anna Zasova, Aleksejs Melihovs

Abstract
Latvia's accession to the EU and its resolute policy oriented toward a full-fledged participation in the EMU, have highlighted the need for a profound investigation into the country's labour market. A flexible labour market is a key policy instrument for a country in the single currency area to ensure an escape from the adverse effects of asymmetric shocks. Labour market flexibility will determine how efficiently the economy of Latvia will develop in the period following its accession to the EU. The paper deals with flexibility of Latvia's labour market using the dynamics of market indicators and assessing its institutional framework.

Key words: labour market flexibility, flexibility of wages, institutional framework

JEL classification codes: C22, E24, J20, J50, R23
2/2005 Modelling Long-Term Competitiveness of Latvia ( 1,97 MB)
Gundars Davidsons

Abstract
The paper aims to measure competitiveness of exports and, hence, also competitiveness of Latvia as a state using foreign trade data. To find out whether Latvia's export capacity and the potential of competitiveness have improved after the country regained independence, a particular focus is on the respective recent dynamics. The theoretical model presented in the paper is a version of the assessment of current export dynamics. The model treats processes of the last decade as a more profound specialisation. Latvia is producing almost the same output as in the early-1990s, without much extra value added embedded in it. The EU accession undeniably boosts the export market share providing competitive advantages vis-à-vis other low-cost economies. Nonetheless, even in the presence of a positive short-term effect, it may adversely affect human capital over longer horizons. This implies that on behalf of the state a more active involvement in the build-up of industrial basis is desirable.

Key words: competitiveness, comparative advantage, real convergence

JEL classification codes: F14, F19, O33, O47
1/2005 Repegging of the Lats to the Euro: Implications for the Financial Sector ( 2,36 MB)
Viktors Ajevskis, Armands Pogulis

Abstract
The paper is a generalisation of L. E. O. Svensson's simplest test of target zone credibility and the drift-adjustment method in the context of anticipated planned repegging. In 1994, the Latvian lats was pegged to the SDR basket of currencies but on 30 December 2004 the lats was pegged to the euro maintaining the existing exchange rate and fluctuation band of ±1% around the peg rate. Three currencies and two time intervals have been used leading to the generalisation of uncovered interest parity and necessitating the use of forward interest rates.

Key words: planned repegging, exchange rate target zone, credibility, market interest rate, arbitrage opportunities

JEL classification codes: D84, E43, E58, F31, G15

2004

4/2004 Pass-Through of Exchange Rates to Domestic Prices in East European Countries and the Role of Economic Enviroment ( 699 KB)
Martins Bitans

Abstract
The paper examines the exchange rate pass-through in a set of 13 East European countries during the period of 1993-2003. The pass-through estimates are derived from a recursive VAR model in first differences, and the impact of exchange rate changes on both the producer and the consumer prices is studied. The estimates obtained for two sub-sample periods generally show an incomplete pass-through over a two-year horizon. In addition, the results imply a considerable cross-country variation and suggest that a significant decline (by nearly 50%) in the pass-through is possible over time. In particular, it is found that the exchange rate pass-through in East European countries is positively and statistically significantly related to the average inflation rate and the degree of exchange rate persistence. Moreover, the results confirm the existence of strong relationship between the pass-through and changes of the import structure. Finally, there is some limited evidence that the magnitude of the exchange rate pass-through might be positively related to the degree of openness to foreign trade of a country.

Key words: pass-through of exchange rate, recursive VAR model, Exchange Rate Mechanism II

JEL classification codes: C32, E31, E52
3/2004 Money Demand in Latvia ( 718 KB)
Ivars Tillers

Abstract
The econometric analysis of the demand for broad money in Latvia suggests a stable relationship of money demand. The analysis of parameter exogeneity indicates that the equilibrium adjustment is driven solely by the changes in the amount of money. The demand for money in Latvia is characterised by relatively high income elasticity typical for the economy in a monetary expansion phase. Due to stability, close fit of the money demand function and rapid equilibrium adjustment, broad money aggregates can be used as indicators of the economic activity.

Key words: money demand, co-integration, exogeneity, vector error correction

JEL classification codes: C22, C32, E41
2/2004 Impact of the Euro Adoption on the Economy of Latvia ( 1,02 MB)
Martins Bitans, Egils Kauzens

Abstract
In the past decade, Latvia's macroeconomic structure and the financial system have undergone momentous and radical changes, and the experience gained so far supports the assumption that the economy has been able to adjust effectively to changes in external environment. The calculations based on the gravity model analysis demonstrate that over longer horizons Latvia's GDP might be up to 19% higher than under a hypothetical scenario of Latvia preserving its national currency. Several indicators of the national structural development (structural changes of GDP sectors, structure of foreign trade broken down by trade partner and main commodity group, etc.) and the analysis of cyclical economic volatility show that in terms of real convergence Latvia often differs substantially from large euro area countries and only on few occasions Latvia's respective indicators display close similarity to the indicators of countries known as the periphery. It does not necessarily imply that along with the euro adoption the impact and periodicity of asymmetric shocks in Latvia are going to increase.

Key words: euro area enlargement, euro adoption, convergence, Maastricht, EU

JEL classification codes: E42, E58, F33, F42
1/2004 Foreign Exchange and Money Markets in the Context of the Exchange Rate Target Zone ( 984 KB)
Viktors Ajevskis, Armands Pogulis, Gunars Berzins

Abstract
The paper has assessed market participants' confidence in the national currency of Latvia in the period between January 2001 and April 2003 using as the basis the position of the lats interest rates within the interest rate corridor. For the purpose of the study, the method of Lars E. O. Svensson was modified taking into account quoted interest rates and exchange rates as well as using the simple interest rate calculation. For the term of up to 1 year, arbitrage opportunities in Latvia's foreign exchange and money markets, likely to arise from the absence of money market participants' confidence in the existing foreign exchange corridor, have not been observed. The assessment of Latvia's money market participants does not signal any realignment possibility for the foreign exchange regime within the coming year.

Key words: exchange rate target zone, credibility, market interest rate, arbitrage opportunities

JEL classification codes: D84, E43, E58, F31, G15

2003

3/2003 Interest Rate Term Structure in Latvia in the Monetary Policy Context ( 2,26 MB)
Jelena Zubkova

Abstract
This paper examines applicability of various models of the yield curve construction to the Latvian money and government securities markets, and analyses the information content implied in the yield curve. Rejection of the hypothesis about the existence of a zero risk premium leads to an inference that forward rates in general do not ensure unbiased forecasts of spot rates, and the pure interest rate expectations theory cannot be applied in interest rate forecasting. Long-term interest rates contain a risk premium that is other than zero. This conforms well to the results obtained from the studies conducted on the financial markets of developed countries.

Key words: term structure of interest rates, risk premium, the Nelson-Siegel model

JEL classification codes: D84, E43, E47, G10
2/2003 Measuring Output Gap in Latvia ( 772 KB)
Dainis Stikuts

Abstract
To determine whether economic progress of a country presents a threat to its macroeconomic sustainability, the difference between actual and potential output is usually used in the formulation of the economic policy. A number of methodologies, including the time series method, HP filter approach and CD function, have been used in the estimation of potential GDP. Potential production factor values were calculated for the needs of the production function. The data used in the paper lead to an inference that the economic growth depends on increases in capital stock and technological progress, both contributing to labour productivity and offsetting workforce shrinkages.
Focusing on the relationship between output gap and inflation, this paper concludes that in Latvia, in contrast to several developed countries, the correlation between output gap and inflation is extremely weak due to the size and openness of the national economy as well as labour market inelasticity. Surveys conducted to date do not produce adequate data for an accurate estimation of the impact the output gap may have on inflation. Inflation is affected by a number of factors, e.g. Latvia's openness to imports, a relatively unlimited external supply of goods for relatively fixed prices, and administratively regulated prices, but it does not depend on the output gap. Hence the excessive demand is to be associated with a rise in imports rather than an upswing in inflation. Therefore, instead of inflation rate, it is the current account that reflects the domestic demand and its development trends more accurately.

Key words: output gap, potential output, production function, NAWRU

JEL classification codes: C13, E32
1/2003 Transmission of Monetary Shocks in Latvia ( 290 KB)
Martins Bitans, Dainis Stikuts, Ivars Tillers

Abstract
This study deals with short-term reactions of the economy to various monetary shocks. The analysis of the financial system of Latvia supports the view that the wealth channel is currently very weak or even non-existent due to a relatively underdeveloped capital market. The importance of various channels of monetary transmission has been tested empirically by using the structural VAR model and small structural macroeconomic model. The analysis provides evidence that monetary shocks are transmitted to the economy mainly through the exchange rate channel.

Key words: monetary policy, monetary transmission mechanism, small structural model, vector autoregression

JEL classification codes: C32, C51, E52

2002

2/2002 Financial Market in Latvia ( 1,36 MB)
Jelena Zubkova, Egils Kauzens, Ivars Tillers, Martins Prusis

Abstract
During the last decade Latvia made a considerable progress and has created an institutional structure and legislative framework to support a market-oriented financial system. The financial sector of Latvia comprises nearly all financial institutions typical of developed markets. The regulatory enactments of Latvia conform to all EU requirements and in some respects are even stricter. Latvia's accession to the EU will be an important turning point for the country's economy, including the financial market, and will provide higher income and wider opportunities.

Key words: financial market, settlement systems, European integration

JEL classification codes: G10, G20
1/2002 Real Exchange Rate in Latvia (1994-2001) ( 967 KB)
Martins Bitans

Abstract
The analysis of the exchange rate in Latvia presented in this publication covers a period from 1994 until 2001. The analysis has been based on two commonly used methods: the single equation approach and the macroeconomic balance approach. The existing fundamental variables in the economy warrant the exchange rate that is undervalued relative to its equilibrium. Therefore, the current exchange rate in Latvia generally corresponds to the current stage of economic development. The real appreciation of the exchange rate with respect to the countries of Western Europe is in line with the appreciation of the trend exchange rate, which is driven mainly by rising productivity in the tradable sector. Therefore, the appreciation of the real exchange rate from 1994 until 2001 has not generally harmed foreign trade. As long as real appreciation is supported by underlying fundamental variables in the economy, it does no endanger macroeconomic stability and growth.

Key words: real exchange rate, foreign trade

JEL classification codes: C20, E20, E52, F10

2001

1/2001 Price Dynamics in Latvia - Experience and Future Prospects ( 1,04 MB)
Martins Bitans, Dace Slakota, Ivars Tillers

Abstract
The Latvian experience shows that the central bank's successful monetary policy, together with the government's prudent policies, helps to reduce inflation. Due to Latvia's small size and high degree of openness of its economy, the exchange rate plays a significant role in determining inflation in the country. The Bank of Latvia's interim objective - the stability of the exchange rate - has been the key to achieving and maintaining price stability. In light of the fact that many factors that determine inflation in Latvia are beyond the central bank's control, the pursuit of a strategy based on inflation targeting appears to be difficult.

Key words: monetary policy, inflation, Phillips curve

JEL classification codes: C13, E31