Practise shifting AD after tax or spending changes, reading effects on output, prices and employment and evaluating multipliers, crowding out, capacity and supply-side…
Latvia becomes a banking capital between the European Union's (EU's) east and west
Latvia regards itself as a financial bridge between Europe's east and west. Since the Soviet Union's collapse in 1991, Latvia (population 2.2 million) joined the EU (population 510 million) in 2004. It has since built itself into a banking centre for people from all parts of Europe and many other parts of the world, although its reputation as a financial centre has been growing since 1988 when two entrepreneurs founded a private bank, Parex Bank, in the capital, Riga.
In the early years of the 21st century, favourable credit conditions in Latvia contributed to an economic boom, but in the global financial crisis of 2007-2008 Parex Bank, by then Latvia's second biggest bank, needed government assistance and was nationalised.
The financial crisis caused Latvia's annual inflation rate to rise rapidly to in May 2008, which was significantly higher than its average annual inflation rate of for the period 1998-2018.
In 2008, the Latvian government decided to substantially reduce the size of the budget deficit, in an attempt to reduce the relatively high rate of inflation, through a series of fiscal measures such as increasing taxation and reducing public spending.
Latvia emerged from the global financial crisis to become the EU's fastest-growing economy. The intention was that Latvia would eventually join the EU's common currency (the euro). Fig. 1.1 below shows the exchange rate of Latvian Lats (the country's former currency) per euro from 2007 to 2013.
Fig. 1.1 Exchange rate of Latvian Lats per euro, 2007-2013
In January 2014, Latvia did join the euro and this was welcomed by business leaders and economists in Latvia, stating that it would improve Latvia's credit rating and attract foreign investors. The governor of Latvia's central bank said: "The euro brings stability and certainty, definitely attracting investment."
However, not everybody in Latvia supported the introduction of the euro. Many people thought that Latvia would lose a certain amount of economic independence and that it would lead to an increase in prices and taxes.
Sources: Adapted from The Financial Times 20 February 2018
Latvijas Banka, accessed October 2018
Analyse, using a diagram, how fiscal measures to reduce the budget deficit could be used by the Latvian government to lower the relatively high rate of inflation.