‘To beat Putin, 25pc inflation is low price to pay,’ says Estonia’s central bank chief

Governor Madis Muller tells Szu Ping Chan that his countrymen are willing to endure hardship to see off the ‘threat next door’

If you think prices in the UK are surging, spare a thought for Madis Müller. The governor of Estonia’s central bank is currently dealing with 25pc inflation, the highest in the eurozone. Electricity prices have tripled in a year. Running a diesel car is 50pc more expensive and baking a loaf of bread costs around 80pc more than a year ago.

“We have this tradition that every Sunday we have a special breakfast with an Estonian dish called tatrapuder and pancakes,” says Müller. “The price of buckwheat [used to make tatrapuder] has probably more than doubled.”

It’s a reminder of issues that go well beyond the kitchen table.

Russia is one of the largest producers of buckwheat, while Ukraine, the breadbasket of Europe, is among the top three exporters of grain in the world. Getting that grain out of the country has been challenging since the Russian invasion.

Weaker supply hasn’t been followed by a fall in demand, leading to soaring prices. Estonians spend a larger share of their monthly income on energy and food than anywhere else in Europe.

So why no protests? A 20pc rise in the price of goods would be enough to spark discontent in other countries

– but not here. For many Estonians, memories of the Soviet era still loom large, Müller says, as does the potential threat on its doorstep.

“I think there’s still an understanding, I hope, that much of the price increases have to do with the war in Ukraine and the Russian aggression. And, of course, Estonians are very much supporting Ukraine in every way we can, and relatively speaking, you could argue that this is still a low price to pay for security.”

Müller has a personal reason to be hawkish. Some of his family were sent to Gulags – or prison camps – in Siberia during the Soviet era.

“I remember the Soviet times. My mother was born in Siberia because my grandparents were sent by the Russians to labour camps there. Also my other relatives have been sent to labour camps. Not all of them came back. So people remember.”

Estonia, a Nato member, has a population of only 1.3m – around a quarter of them ethnic Russians. The country also shares a 183-mile border with Russia.

“We have always known that Russia is a threat next door, and it’s not a reliable partner in any sense,” says Müller. “This has just been proven also to everyone who still didn’t feel that way. So now that Ukraine is fighting for its freedom, we need to stand with them for all of us in Europe.”

Solidarity also means pivoting away from cheap Russian energy. The EU has pledged to ban most Russian crude imports by the end of the year, and refined products such as petrol and diesel by early 2023. The process has been painful. But Estonia has a head start. It has relatively little dependence on Russian gas, with just under three quarters of Estonia’s energy supply coming from domestically produced oil shale. In addition, almost no natural gas has been delivered to Estonia from Russia since April. But energy prices are still soaring amid a series of maintenance issues at the country’s oil shale plants. A lack of nuclear power or other diverse sources of energy to compensate puts additional strain on a market that has traditionally passed on price changes quickly to consumers.

The worst thing for Müller? There’s little he can do about it. Interest rates are not set in Tallinn, Estonia’s capital, but 1,200 miles away in Frankfurt.

Müller represents the interests of just one of the 19 eurozone countries that the European Central Bank sets policy for. And as one of the bloc’s smallest nations, that means compromise.

The ECB’S deposit rate stands at just 0.75pc. Analysis by the OECD shows it would be closer to 11pc in Estonia if policymakers followed a simple equation that ties rates to inflation and economic growth.

“It’s probably true that if we had independent monetary policy only for Estonia, then given the level of inflation that we’re having and the tightness of the labour market until recently, we would probably have higher interest rates,” says Müller, who has held the central bank’s top job since 2019. “But I don’t consider such thought experiments really meaningful.”

Rates at 11pc would probably trigger a deep recession, in any case, so there is no easy solution. Estonia has become accustomed to ceding control of monetary policy. In 1991, when the Baltic nation became independent of the Soviet Union, it replaced the rouble with its own currency, but proceeded to peg it to the Deutsche Mark to try to stabilise the economy. It swapped the German currency for the euro in 2011 when it joined the single currency.

“For 30 years, we haven’t had our own independent monetary policy, so the economy in general is accustomed to the idea that the wages, and the workforce have to be flexible,” he says.

“If we are discussing monetary policy at the ECB then I’m not thinking about inflation in Estonia, but what I think is best for the euro area.” That doesn’t change the fact that price rises remain stubbornly high.

What can Müller do? In terms of his own remit, he says the ECB must continue to be “bold” on interest rates.

“If you wait too long with increasing rates, in a situation where the inflation is so high, we run the risk of adding more permanent price pressures. And unless you act decisively, then you may need to compensate for it later, and that will be even more costly.”

The ECB is already arguably behind the curve. It only started raising interest rates in July. The Bank of England started in December 2021, while the US Federal Reserve began lifting rates in March.

Müller disagrees, highlighting that the bank has lifted rates by 1.25 percentage points since the summer – including a 0.75 percentage point move at its last meeting. “I think you could argue the ECB has been bold already with rate hikes. And I think we need to continue being bold. I don’t want to give you an exact number of what I think it should be next time. But I think something around the same level is called for.”

Not being fully in control of monetary policy allows you to step beyond your remit sometimes. Whereas Andrew Bailey, the Bank of England Governor, would not dream of telling Kwasi Kwarteng, the Chancellor, how to tax and spend, the central bank in Estonia has taken the opposite approach. Less than a month ago, its monetary policy report actively told the government to be careful how much money it spends. It warned that the government’s budget was already “deep in deficit” and even more spending will only end in tears. Müller turns to the long-term impact of the war in Ukraine.

“We see even more clearly how unreliable our neighbour is. We did not have that much exposure in terms of trade with Russia and much of it will be gone now permanently.”

In 2021, Russia was Estonia’s eighth largest export partner and second biggest source for imports, with oils and coal the biggest purchases. Müller says this is already changing: “Our economic ties with Russia will be cut to a very large extent, which means that some of the firms will have to adjust, for example those who were relying on some raw materials from Russia. But then I think that’s the price we need to pay.”