The global and European roots of high inflation The search for the causes of the current high inflation starts in the aftermath of the Covid-19 pandemic. The global economy recovered fast once the pandemic ended and the restrictions on consumption and travel were lifted. Aggregate demand in our economies bounced back, and it was also boosted by the wide-ranging support measures that governments and central banks offered to help companies and households cope with the crisis. It turned out that not all companies could respond quickly enough to this increase in demand, as some restrictions lingered and supply chains remained fractured. This put pressure on input prices that was then passed on to consumers. Then Russia attacked Ukraine, and this caused energy and commodity prices, including food prices, to increase sharply. The energy crisis hit Europe especially hard as the European Union as a whole and many member states were heavily dependent on Russian oil and gas. Russia weaponising energy pushed inflation up to levels not seen since the last great oil shock in the 1970s and 80s. By October last year inflation in the euro area had passed 10%, though inflation rates were very different across the  1/8  BIS - Central bankers' speeches  member states, ranging from 7% in France to above 20% in the Baltics in that month. Inflation in Slovenia was just below the euro area average at 10.3%.
A third and more general reason why inflation has been high in the Baltic countries was that the economic impact of the pandemic was more limited in our region and the pandemic was followed by a very strong and swift recovery. Expansionary fiscal and monetary policies combined with strong domestic demand pressures therefore contributed to an increase in inflation. On top of this was a change in the Estonian pension system in the autumn of 2021 that allowed individuals to start withdrawing their  2/8  BIS - Central bankers' speeches  pension savings before they reached retirement age. Some of this money was used to fund private consumption, which further increased inflationary pressures. The substantial dispersion of inflation rates between the countries of the euro area poses the question of how harmful these differences are in a monetary union. Obviously there will always be differences between the structures of our economies, and so there will always be some differences between the inflation rates in different countries. Such differences have been around since the euro was first introduced, though for most of the time they have been minor. Large differences in inflation rates could however lead to problems with the smooth functioning of a common currency area. An obvious problem is that a common monetary policy allowing nominal interest rates to be similar in all of the euro area countries will lead to differences in real interest rates if there are differences in inflation.