Fiscal council offers a new visual for economic cycle assessment - heatmap  10 December 2018

Fiscal council offers a new visual for economic cycle assessment - heatmap

For better understanding of the cyclical changes in the economy, the Fiscal discipline council, like other European independent fiscal authorities, uses a visual to characterise the economic cycle - the so-called heatmap. This tool confirms that economic growth in Latvia is fast and exceeds its potential, therefore, the state budget fiscal balance has to be planed with a surplus.

Timely recognition of economic cycles and their characteristic indicators is essential as they are the basis for the development of the countercyclical fiscal policy, namely, restrictive policy should be introduced in the upturn phase (including state budget surplus) while stimulating fiscal policy should be introduced in the downturn phase.

At the moment, the following indicators are used for map visualization:

  • Core inflation – HICP excluding energy, food, alcohol and tobacco;
  • Average wage – average monthly gross wage in all sectors;
  • Unemployment rate in the population of 15 to 74 years;
  • Employment rate in the population of 15 to 74 years;
  • Vacancies – number of job vacancies;
  • Capacity utilization – current level of capacity utilization in manufacturing industry;
  • Insufficient demand in construction as the main factor limiting building activity (survey);
  • Insufficient demand in industry as the main factor currently limiting production (survey);
  • Insufficient demand in services as the main factor currently limiting business (survey);
  • Economic Sentiment Indicator.

The composite indicator or the average of all the above-mentioned variables is calculated for the characterisation of the economic cycle. More information about the methodology and methods of data calculation can be found in the MS Excel document. It is planned to extend the heat map to other cyclical indicators.

The new graphic or heat map shows a "heating-up" of the composite index since the beginning of 2017, but especially in the first and second quarters of 2018, which confirms a rapid economic growth. Of course, there is no such tendency in Latvia for the first time - since the year 2000 it has been observed since the end of 2005 and the beginning of 2006, which is known as the period before the global economic crisis.

Each heating cycle phase are characterised by different indicators, for example, the fast-growing inflation in 2006, which is currently not observed in Latvia. But, as in the past, the labour market is the hottest one, with an increase in employment rates and, at the same time, an increase in job vacancies. The capacity utilization of the manufacturing is also historically at its highest level, and insufficient demand is no longer a major factor limiting business activity.

Since 2011, Latvia has been experiencing economic growth again. At the same time, as the economy continues to evolve and the gap spreads positively (i.e., the actual output of the economy exceeds its potential output), the state budget balance for the coming year is still projected to be in deficit. Meanwhile, the opposite situation is observed in our neighbour countries - the governments are planning annual budgets with surplus (see the news entry: Unlike Lithuania and Estonia, Latvian state budget does not use good years opportunity to build up reserve). Moreover, this practice is being implemented in the neighbour countries, despite the fact that the economic growth rates in Lithuania and Estonia in 2018 are forecasted not so fast as in Latvia, respectively 3.4%, 3.5% and 4.1%.

The Council has repeatedly emphasised that in the years of economic growth, the government needs to plan a fiscal balance of the budget with a surplus. Currently the economic in Latvia is growing rapidly and exceeds its potential, as evidenced by the assessment of various cyclical indicators.