Just as life is never purely black or white for any of us, a country's economic developments cannot be described in a single colour either. On the eve of the new year, 2026, there are three reasons why I feel cautiously optimistic about the prospects for the European economy (Latvia's included); I will also mention two trends that are, in my view, less positive and will have to be overcome in future.
Three reasons for cautious optimism
1. Price stability is returning. The Governing Council of the European Central Bank (ECB) has succeeded in bringing euro area inflation back to its target level, namely 2% per year, which is the optimal rate for economic development. The period of high inflation is behind us – businesses and households no longer need to worry about prices rising too steeply and money losing its value. There is therefore no reason to expect significant changes in interest rates in the near term either, as recent months' comments from members of the ECB Governing Council also confirm.
In Latvia the story is different – inflation is, and is expected to remain, higher over the next few years too (slightly above 3%). Faster wage growth is pushing up the cost of labour-intensive services; meanwhile food prices in the budget-brand segment in Latvia are high. Although food prices in Latvia have eased somewhat in recent months in response to the global fall in prices, this trend remains fragile. There is still much to be done next year to sharpen competition among retailers.
Competition among commercial banks has also been weak in the past, which made loans expensive and the conditions for obtaining them strict. In this area, 2025 marked a significant turning point – lending now "props up" the economy rather than trailing behind it, which promises greater investment and economic activity in future (see pages 35-36 here).
2. The external environment is better than expected. The negative impact on the global economy of the trade war launched with much fanfare has so far proved smaller than expected.
Nor was the political instability in Europe's major states (Germany, France), which I mentioned a year ago, able to halt economic growth – European Union (EU) economic growth in 2025 turned out to be somewhat faster than expected. The EU is home to 450 million people; it is an enormous market, and its economic upturn means greater export opportunities for Latvian companies. Yet whether we are able to produce the high value-added products the global market demands depends solely on our own knowledge and skills.
3. Society's prosperity is growing (not equally for everyone, but the averages are nonetheless rising). Average wage growth in Latvia is expected to be around 8% per year, or at least twice as fast as inflation. That means greater material well-being – we can afford ever more goods and services. Consumption is not an end in itself, but without a stable material foundation it would be hard to be happy.
Unemployment is expected to remain low, which makes the labour market favourable to employees, pushes businesses to introduce more and more automation solutions, and requires public policy to work at activating the domestic reserves of labour (rather than creating new jobs, as was still the case a dozen or so years ago). It is genuinely hard to imagine a better time for a young person to enter the labour market or for an experienced specialist to return to work even after a longer break.
Two less positive trends that will have to be overcome in future
1. The state's influence in the economy is too great. Over the past six years, the public sector (that is, central and local government) has significantly expanded its place in Latvia's economy. Before the Covid-19 pandemic, state budget expenditure stood at 40% of the size of the economy; now it is already 46%. The increase is considerably larger than would be justified by the needs of the national defence priority. A rise in government spending would even be desirable at times of economic crisis (for example, during the pandemic, and also in 2022, as energy prices rose steeply), but not now.
Nor should we resign ourselves to an annual budget deficit of around or even above 3% of the size of the economy (see slide 29 here). An excessive budget deficit increases government debt and the cost of servicing it – every year, a few hundred million euros must be set aside for interest payments on the debt. That is money which cannot be used for areas that matter to society, such as health, education or security.
Choosing between the two routes to reducing the budget deficit, the clear preference would be to cut government spending (through gains in efficiency). The alternative solution is to raise taxes, which would have a negative effect on economic growth.
People should be thanked for long working hours and productive work for the good of society, not punished with higher tax rates. A more effective weapon in the fight against income inequality is to set strong social "lifts" in motion (for example, excellent education that is available regardless of parents' income).
2. Economic growth is not fast enough.
An annual growth rate of 1-2% in the EU and 2-3% in Latvia is fairly modest. We are not currently in an economic crisis, so Roosevelt's 1930s Keynesian policy ("warming up" the economy by making enormous investments without worrying about how useful they are) will not help. Nor are we any longer a land of cheap labour; if production still exists somewhere in Latvia solely because manual work is cheap here, that business model is living out its final years and must reckon with extinction, for instance as Ukraine, a country with even cheaper labour, moves closer to the EU.
Economic development therefore does not mean producing the same things, only more of them; we must move towards creating unique, high-quality and sophisticated goods and services with high added value. The recipe for such economic growth has long been known – human capital (the education and health of the population), investment and innovation (here what matters is the return and cost-effectiveness, rather than the sheer amount of money invested).
Governments should not regulate the process of economic growth with piles of planning documents, strategies or excessive support mechanisms (the latter is merely a redistribution of money from one economic agent to another), but should first and foremost create an excellent business and living environment in which entrepreneurs and residents would want to, and be able to, realise their talents.
EU economic growth can be fostered by a European single capital market (which would allow a larger share of European households' savings to be invested directly in European companies rather than in the US and other regions), a European single market for services (so that more companies expand across national borders and gain a positive effect of scale), as well as the removal of excessive bureaucratic barriers to doing business and to work. One step in this direction is the simplification of banking sector regulation, which was spoken about ever more loudly in 2025 and which will be a priority for the ECB and the EU in 2026.
Latvia's economic achievements are considerable – there are not many countries in the world that have developed as rapidly over the past 30 years. Yet the examples of Lithuania and Estonia show that we can do even better; moreover, the quality-of-life standards of the Scandinavian countries point to a long-term vision to aspire to
In conclusion
Economic forecasts do not mean a foregone conclusion, but rather the most likely trajectory of events, one that can and should be changed. As I write every year – each of us (as an individual) and society as a whole can change for the better, every day, every year. Recent years have shown that external developments cannot be predicted, so all that remains is to rely on ourselves. What kind of economy Latvia and Europe will have tomorrow depends to a large extent on what we do or fail to do today.
Happy New Year!