Paying attention to inflation
The inflation rate is common parlance in discussing the macroeconomic situation. It is important for the Central Bank, one of whose main functions it is, now subsumed within the ECB, to attempt to influence the rate to keep it around a given target. In some countries, such as the UK, the Governor of the Central Bank has to give written satisfaction to the Finance Minister (Chancellor of the Exchequer in the UK) if the rate varies up or down from the set target.
In Malta the rate is particularly relevant since it feeds directly into the cost of producing goods and services via the statutory increases mechanism, COLA. Yet it is still not very clear to most people what the inflation rate is. Malta uses three measurements, all based on movements in the Retail Price Index (RPI).
The National Statistics Office includes in its methodological notes a short description of the measurements in its monthly news release on price movements. The monthly rate compares price levels between the two latest months. This measure is up-to-date, but it can be affected by seasonality.
The annual rate measures price changes that have occurred in the month under review, to changes during the same month of the previous year. This generally smoothes out seasonality. It is responsive to recent changes in price levels. But, it can be influenced by one-off effects on the price level in either month.
The best measure of inflation based on the RPI is the 12-month moving average rate. This is the measure of inflation officially used in Malta, particularly to determine the statutory annual cost-of-living increase (using the moving average up to September).
This measure overcomes the volatility of the monthly and annual rates. It does so by comparing average retail price indices in the latest 12 months to the average of the previous 12 months. The 12-month average rate of inflation can still be affected by one-off developments. A major development occurred some years back when the VAT basic rate was increased from 15 per cent to 18 per cent.
On the other hand once an exceptional factor moves out of the 12-month moving average the cost level remains at the high it had scaled when introduced.
This feature of the cost of living is better understood by reference to the increases in water and electricity prices before the government decided once again to absorb them against current revenue, rather than let Enemalta recover them through its tariffs. Higher water and electricity tariffs raised the cost of living. This stabilised once 12 months had passed from the last increase.
That did not mean to say that water and electricity tariffs declined. They remained as high as when they were first jacked up. Statistics do have a habit of creating a technical illusion, which is swiftly set aside by consumers, who measure prices by what they fork out of their pockets.
Price changes reflect a process of movements which, through stock measurement at a single point in time through the price indices, give an indication of what is going on. It is that net basis of the movement in the RPI between October and September of the latest year relative to the previous year that determines the size of COLA.
By the time that it is announced in the Budget speech it is already considerably out of date. That is because the COLA outcome measured up in September only comes into effect on January 1.
That is not to say that the COLA measurement is a useless exercise. Employers, just like the International Monetary Fund and the European Commission would like to see Malta revisiting the statutory cost of living increase, for instance by making it apply to non-unionised labour only, or to net it out of negotiated collective agreements increases.
The issue comes up for public airing when the Budget is being prepared, which starts now. No doubt it will also once again occupy the attention of the members of the Council for Economic Social Development.
For all that nothing has changed. The unions resist tampering with COLA. The government says that COLA has worked well enough and need not be touched, obviously doing its best to avoid confrontation on the matter. With a general election not farther away than some nine months at the most it is unlikely that any changes to the COLA mechanism will be entertained.
However, the existence of the mechanism can be put to better use, aside from the way it determines statutory wage increases. It can be used to educate the public about the way inflation is measured. It is not enough for the prices data issued by the NSO to be familiar to those whose business it is to deal with statistics. The public needs to have better realisation of what is going on.
The authorities and the MCESD should also make better use of the process to arrive at COLA by attempting to recommend or take remedial action along the year. Price controls are a thing of the past. But there should be deeper official analysis to determine to what extent government-induced costs, for instance, are fuelling inflation, and whether there are sectors where competition is not really working, notwithstanding total liberalisation of trade once we became an EU member.