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That may at first sound a bit strange but if inflation is to come down then a recession would certainly help – lower economic activity implies lower demand for energy which implies lower energy prices, which will lower inflation.
And with inflation running much higher than wage growth, i.e. with real wages dropping, leaving most with quite a bit lower purchasing power, I am quite sure we are in for a recession in 2023. A small and short one, possibly just in end-2022 – beginning of 2023 but I think it is coming.
Forecasts from Bank of Latvia (BoL), the Latvian Ministry of Finance (MoF), the International Monetary Fund (IMF) and the European Commission (EC) are not (yet?) so gloomy but that may be due to the time the forecasts were made, see Figure 1 – 2022 is a year where economic data has changed dramatically during the year, both in terms of growth and inflation. The year started with significant growth due to what we could call a post-pandemic surge. Then Russia invaded Ukraine and sanctions reduce exports to Russia while dramatically increasing energy prices eat away at our incomes with both effects leading to a drop in demand – and thus growth – in the economy. Add to this higher interest rates from the ECB and you have yet another effect that will dampen economic activity.
Figure 1: Growth forecasts for Lavia for 2022 – 2024 from Bank of Latvia (BoL, June 2022), the Latvian Ministry of Finance (MoF, July 2022), the International Monetary Fund (IMF, April 2022) and the European Commission (EC, July 2022)
Sources: EC, IMF database, MoF, BoL
I am thus quite sure that when forecasts will be revised, they will revised downwards.
But as to my headline: I am not all that pessimistic about that. If a recession strikes, then it strikes at the “right” time if such exists. The economy is currently running at very high capacity with unemployment being at historical lows, see Figure 2.
Figure 2: Latvian unemployment rate, 15 – 74 year old, 2002 Q1 – 2022 Q2
Source: Official Statistics Portal of Latvia
Another indicator of an overheated labour market is the number of vacant jobs – the number of vacancies today is almost as high as just before the pandemic and (seemingly; data for 2007 is absent) higher than during the credit boom (which says something!!).
Figure 3: Number of vacant jobs, 2008 Q1 – 2022 Q1
Source: Official Statistics Portal of Latvia
In short, the economy looks quite overheated at the moment and with lower inflation being on the wish-list for everyone, a slowdown of the economy or even a small recession should not be seen as a macroeconomic tragedy. Rather the opposite.
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and Vice-Chairman of the Fiscal Discipline Council of Latvia.
Points of view expressed here are not necessarily those of the Fiscal Discipline Council’s.
