The Bank of Lithuania defends the monetary and fiscal policy measures implemented by central banks and governments to protect from prolonged recession and financial tensions after the shocks of recent years. While the economy has succeeded in avoiding a deep recession, another acute problem has emerged: a sharp rise in inflation, which lasted for too long. Since last year’s peak, the annual inflation rate in Lithuania has decreased by a factor of five. Will this last? How to fight fire with fire will consolidate and reflect in the core?

In order to increase Lithuania’s economic resilience, reduce the dependence on foreign energy suppliers, and ensure a reliable and secure energy supply, the narrative recommends close cooperation between policymakers and businesses in the green transformation of the economy.

To achieve this goal, governments are advised to make targeted use of the Recovery and Resilience Facility (RRF). It is believed to be a strong incentive for the country’s economy to return to sustainable growth. According to the European Commission, by the first half of this year, approximately €830 million, or nearly 38% of the total allocated RRF support, had been transferred to Lithuania. This year, the volume of EU investment funds is expected to reach 1.7%, and next year – almost 2% of GDP.

But the current extraordinary inflation and, in some cases, actual stagflation, is actually the result of a macroeconomic mistake of the state economic policy of developed countries: the attempt to moderate multifactorial market processes and form “conditional behavior” for the illusory purpose of leveling the negative phases of economic cycles.

The deep motives of such actions are determined by electoral interests, where the essence of the error lies in the expansion of state paternalism and hypertrophied macroeconomic stimulation of processes in an open market economy.

Against the backdrop of supply-side disruptions associated with the pandemic constraints, the state has decided to stimulate directive-blocked demand in unprecedented amounts. This was implemented through a combination of fiscal and monetary interventionism. Direct payments to the population led to the inflation of exchange-traded assets. Support for loss-making and inefficient enterprises to save jobs and the adoption of huge infrastructure programs were combined with maximum monetary easing through zero-funding rates and large-scale programs of direct injections of liquidity into the banking system through the redemption of public debt.

The result of such pumping demand on the background of problematic supply was a cascading deterioration of the situation. The deplorable state of production was intensified by a sharp decline in the labor force and the inability to fill vacancies. This naturally increased wage inflation, which, together with other factors of production inflation, such as logistical gaps and shortages of components, contributed to a sharp rise in producer prices.

The significant factor in production inflation has been the rise in commodity prices, primarily energy prices, due to:

• the asset inflation, partly artificial and created by the government,
• the geopolitical tensions in Eastern Europe,
• the forcing of the green agenda and the compression of traditional energy sources without sufficient development of alternative sources.

On the other hand, monetary tightening in such an environment is incapable of sanitizing the economy for a new growth cycle. This is a systemic shift where previous measures do not work in their usual mode: monetary tightening will certainly deflate consumer activity, but the structural problems on the supply side will only be exacerbated by monetary tightening.

The condition of a free and competitive private market with a minimal state is therefore essential.

Otherwise, a decrease in efficiency will follow, as fiscal stimulus in the form of social and infrastructure programs have already been adopted and the effect of squeezing business by the state will reduce opportunities for private business, especially in an environment of rising costs of funding.

Ultimately, it is state intervention that:

• multiplies the risks and negative effects of market cycles,
• expands their volatility,
• generates the effect of spiral reproduction of economic inefficiencies: the previous mistake can only be corrected by the next, even bigger mistake.