Anatomy of inflationary shock in Lithuania: causes, effects and implications
ENAfter a decade of muted consumer price growth, inflation has picked up again, with the price increase of many goods and services spiking in 2022. Two extraordinary events – the COVID-19 pandemic and the Russian aggression against Ukraine – played a leading role in the jump in inflation. The high risk of deep recession in 2020-2021 forced governments and central banks to implement various supportive measures. As the economies adapted to the pandemic, recoveries followed unexpectedly quickly with the help of expansive monetary and fiscal policies. Nevertheless, pandemic-induced supply-chain disruptions have resulted in delivery delays and increased production and transportation costs across the globe. Thus, recovering demand faced a still-constrained supply. In 2022, recovering economies were hit by another shock – the Russian war against Ukraine. The war contributed to a rise in energy prices (notably, that of natural gas, which Europe was especially dependent on). All these factors – expansionary fiscal and monetary policies, rapidly recovering economies, residual post-pandemic disruptions in supply chains, and increases in energy prices – have led to an unexpected rise in inflation throughout the world, including Lithuania. In this occasional paper, we analyse various topics related to inflation in Lithuania, predominantly focusing on the recent inflationary episode. The latter rise of inflation was unprecedented. In 2022, average annual inflation reached 18.9 per cent in Lithuania, a level which had not been seen for more than two decades. We analyse the nature of the recent inflation shock, duration, underlying causes, and consequences. While this study mainly deals with Lithuania, it also addresses the question of whether its inflation dynamics differs from that in the rest of the euro area, and if so, how.The study thus contributes to a more nuanced understanding of inflationary process in Lithuania. While integrated within the general topic, each of the chapters in the study can be seen as separate analytical notes focusing on distinct topics. In Section 1.1. (“Stylized facts of consumer price dynamics”) and Section 1.2 ("Dynamics of consumer, producer and input prices”), we provide an overview of the dynamics of inflation and its components in Lithuania over the past two decades. During the economic boom of 2004 to 2008, Lithuania experienced an upward pressure in consumer prices. This ended in 2009 with the global financial crisis, which triggered a significant downturn in the Lithuanian economy. Afterwards, a period of relative stability in inflation took place until the COVID-19 pandemic. At its start in 2020, consumer price inflation decelerated, but price growth picked up in 2021-2022. Since reaching its peak in 2022, the annual inflation rate has been steadily declining. Historically, energy prices in Lithuania have been characterized by especially high volatility. During periods of higher inflation, they have been one of the main drivers of inflation, while during periods of lower inflation, energy prices have been an important factor reducing it. In Section 1.3. (“Inflation expectations of Lithuanian households”) and Section 1.4. (“Inflation expectations of Lithuanian firms”), we use existing survey data on Lithuanian households’ and firms’ inflation expectations to better understand their evolution in the recent high inflation environment. A clear upward bias can be observed in households’ and firms’ inflation expectations. However, there is also a significant co-movement between actual inflation and inflation expectations. As inflation started to decline in 2023, similar trends can be observed in inflation expectations.In Section 2.1. (“Effects of energy supply shocks on price inflation along the production chain”), we assess the impact of energy supply shocks on price inflation along the production chain in Lithuania. The energy shocks are identified in two independent monthly BVAR models (Messner and Zorner (2023)). Producer price inflation for energy and food reacts at half the rate of equivalent international inflation in the month of the shock and then continues to rise for a year or year and a half. Consumer food price inflation reacts to a similar extent as producer food price inflation, while consumer energy price inflation reacts to a lesser extent than producer energy price inflation. More importantly, these reactions occurwith a lag of about one year after the shock. Finally, the impact at the bottom of the production chain, i.e. on core consumer price inflation, is quite limited. Overall, this section shows that energy supply shocks propagate gradually through the supply chain over time and are not passed on, on a one-by-one basis, to the final consumer. [...] Keywords: inflation, convergence, price level, supply shock.
