No it will not – the headline was just a shameful trick to make you start reading. But it seems that many think that high inflation will result from euro introduction. This makes me raise two questions:
1) What does history tell us?
2) How to avoid potential price increases?
I have looked at the eleven founding members of the Eurozone, EZ-11 (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain) from 1997 to 2002, i.e. from two years before the formation of the Eurozone until three years after.
Figure 1 shows inflation development in EZ-11. Inflation indeed rose after the introduction of the euro but from a very low level of around 1% to a still low level of around 3% per year.
Figure 1: Annual inflation in EZ-11 (the eleven original countries of the Eurozone), 1997 – 2002. The red line indicates the inception date of the euro
And not very strange – the introduction of the euro coincided with a small boom in EZ-11, see Figure 2, which typically results in higher inflation via a tighter labour market.
Figure 2: Growth rates in EZ-11, 1997 – 2002
But what most likely had a stronger impact was the euro depreciating quite sharply for a couple of years against the American dollar, see Figure 3. The euro opened in 1999 at 1.18 USD/EUR but by May 2001 had fallen to 0.86 USD/EUR, a fall (depreciation) of 27%, making US goods (and goods of countries fixing their currency to USD such as Lithuania at the time and partly, via its SDR peg, Latvia) more expensive in the Eurozone, thus creating imported inflation.
Figure 3: The USD-EUR exchange rate, USD per EUR, 1999 – 2002
Source: European Central Bank
The depreciation of the euro was partly a result of being a new currency with untested credibility – that effect will not be repeated when/if Latvia joins, of course.
But we should expect somewhat higher inflation but not, not, not! stemming from euro adoption, rather from current inflation being ultra-low: In February inflation in Latvia was a mere 0.3% on an annual basis and prices even dropped from January to February.
But could it be that some individual goods might see significantly higher prices? Some evidence from especially introduction of cash euro (2002) says so, see e.g. section 2 of this fine overview by Paul de Grauwe, perhaps the foremost expert on the euro, of the euro’s first ten years. Professor de Grauwe provides some evidence from Italy so I used Eurostat data to try to confirm this, see Figure 4. Whereas overall inflation was very subdued and similarly for overall food prices, a few sub-groups saw rather high price increases (I checked many more without similar results) such as fruits and vegetables.
Figure 4: Annual inflation rates for selected items in Italy, 1997 – 2002
Could that happen here? A good argument against is the conversion rates of Italian lira and Latvian lats into euro and the fact that we all suffer from some degree of money illusion, i.e. the fact that makes 0.95 lats sound a lot cheaper than 1.02 lats. The conversion rate for Italian lira was 1936 lira per euro i.e. in euro terms prices looked very low and it was perhaps easy for some shops to divide old lira prices by “only” 1500 or 1600 or so, thereby creating a price increase in terms of euro. In Latvia, due to the strong nominal value of the lat it is the other way round. Prices, when recalculated fairly, should rise 42.3% (since the exchange rate is 0.702804 LVL/EUR and one divided by that number is 1.423). Prices will thus look higher already and attempts to raise them further might backfire.
The best thing is of course to have prices listed in lats and in euro as soon as possible and for a very long period – years – after joining the Eurozone. And naming and shaming those who might attempt to sneak in a price increase here or there.
Inflation will go up – but a) not all that much, b) mostly because it is ultra-low now, and c) partly because of overall growth of the economy.
But these are not effects of joining the euro!
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga