In Latvia, the prices of products and services have picked up the pace. Inflation was on the rise in June (+19.3% year-on-year), with prices growing by 2.4% month-on-month. Moreover, June can still be seen as the “silent period” that followed the surge in prices reflected in May’s electricity bills and that preceded the entry into force of the new gas tariffs in July. Analysts suggest there are grounds for wondering whether prices are raised in line with the cost increase or simply by taking advantage of the situation and referring to the inflation raging nearby as the reason. In the first quarter, corporate profitability was, on average, close to the long-term average. It appears businesses have managed to transfer the cost increase to the prices and make consumers pay for it. Still, as the savings built up during the pandemic are dwindling and the average wage is rising slower than inflation, a weaker purchasing power is expected to cause a decline in demand. Will that boost economic growth or the probability of an incoming recession?

With the pandemic-related restrictions losing their grip, the economic activity enjoyed significant growth during the first quarter. Russia’s invasion of Ukraine has also created more bustle by encouraging purchases of raw materials, components, and finished products for fear of their availability and price in the future. The support measures for Ukraine and war refugees have also bolstered spending. Private consumption was the main driving force during the first quarter. Along with easing the pandemic-related restrictions, the availability of shops and various services contributed to the spending rise. Still, the backdrop of the war and the effect of prices on solvency raise concerns about the future. The answer “I spend the savings built during the crisis” is becoming increasingly popular within the Omnibus survey conducted by SIA Latvijas Fakti and commissioned by Latvijas Banka. At the same time, the answer “I’m going to build additional precautionary savings” remains the most popular one. European Commission data also show that consumer sentiment deteriorated significantly in March and May.

In popular thinking, increases in government spending and central bank monetary pumping strengthen the economy’s overall demand. This, in turn, sets in motion increases in the production of goods and services, leading to the belief that “demand creates supply.” But, if individuals do not allocate enough savings in order to support increases in the production of goods and services, the economy cannot expand. Various individuals who are employed by the government expect compensation for their work. One of the ways it can pay these individuals is by taxing others who are generating wealth. By doing this, the government weakens the wealth-generating process and undermines prospects for economic recovery. In order to be able to exchange something for goods and services, individuals must first have something to exchange. This means that in order to demand goods and services individuals must first produce something useful. Hence, supply drives demand, not the other way around. Increases in government spending result in the diversion of savings from the wealth-generating private sector to the government, thereby undermining the wealth-generating process. Likewise, monetary pumping sets in motion the wealth diversion from wealth generators toward the holders of pumped money.

The export turnover of goods and services grew mainly due to the price increase, with the actual volumes rising moderately. A more buoyant growth was observed in relation to services that also became more available abroad, as the pandemic-related restrictions were eased. Real imports of goods and services witnessed a steep rise in 2021; it was provoked by building reserves owing to the supply chain disruptions during the pandemic. The flow of imports did not lose momentum in the first quarter either as upon Russia’s invasion of Ukraine the supply chain disruptions were expected to escalate, thus producers rushed to restock the shelves of the warehouses.