Relationship Between Inflation and Economic Activity and Its Variation Over Time in Latvia

Abstract: This paper studies the relationship between inflation and economic slack in Latvia with a particular focus on its time variation. The results suggest that the Phillips curve for Latvia had been steepening before the crisis against the backdrop of rising inflation. In the more recent years, there has been tentative evidence of the Phillips curve flattening as Latvia's economy entered a period of very low inflation. If the current trend of an even weaker response of inflation to economic activity in Latvia persists and proves to be statistically significant, unconventional monetary policy instruments may be of limited effectiveness to control inflation in Latvia. This calls for structural reforms aimed at increasing competition and reducing price stickiness.

Keywords: inflation, Phillips curve, business cycles, Bayesian estimation

JEL codes: C32, C51, E31, E52