The National Statistics Office recently published data for May this year regarding the retail price index and the rate of inflation. The data on the retail price index shows an annual rate of growth of 2.38 per cent, while the inflation rate shows an annual rate of growth of 1.95 per cent. There is no doubt that this data is positive and should be very encouraging for Maltese exporters of goods and services and monetary policy makers, even though the rate of inflation is at its highest level since December 2002 and has been consistently rising since October 2003.
Looking at the components of the increase in the retail price index, one notes a slight decrease when compared to May 2003 in the index for food, which is the major item of expenditure in the shopping basket of the average Maltese household. However, one also notes a worrying increase over the same period in the index for housing. Probably the movements in the indices of the other items fall within the norm.
It is worth noting that the expected rate of inflation for 2004 in the whole of Western Europe is of 1.9 per cent. The 10 states that have just become members of the European Union are expected to have an average inflation rate of 4.3 per cent this year. Countries classified by the World Bank as being high-income countries are expected to have an average rate of inflation of 1.8 per cent while countries classified as middle-income countries are expected to have an average rate of 5.3 per cent. This means that we are very much within the international averages.
Data about inflation always provides for interesting discussion in Malta because it has a direct link with the issue of the cost of living, an issue that has been a major concern in this country for decades.
Therefore even when the rate of inflation is low - and consequently the increase in the cost of living is small - people will always tend to claim that prices are out of control. In fact there is very much the tendency to get accustomed to low inflation and for any jump in the inflation rate to be seen as catastrophic for one's personal financial situation.
On the other hand traditional economic theory has always associated a low inflation rate with unemployment.
And up to a certain extent this linkage has proved itself to really exist, starting from the recovery following the Great Depression in the 1930s, to the present day.
The most recent example is Japan, whose economy has deflated significantly since the beginning of the 1990s, with rising unemployment and low levels of inflation.
An inflationary policy has always been thought to generate wealth and employment because it is thought to create economic activity.
However, with time, some have started to doubt the wisdom of such policies because inflation is known to destroy business and consumer confidence.
In effect, successive attempts to reflate the Japanese economy have failed to generate the desired results because business and consumer confidence had been shattered and there were no signs at all of a recovery in either of these two aspects.
Moreover with the increasing globalisation of most economic activities, inflationary policies are known to render businesses uncompetitive because they could lead to increased costs. In the meantime it has become accepted reasoning that low inflation keeps interest rate levels down and low interest rates are a stimulant to investment.
So where does this leave us? Is low inflation a good thing or a bad thing for Malta? I tend to believe that this country needs low inflation because it is very vulnerable to international developments.
The extent of the openness of the Maltese economy makes it compulsory to keep costs down to enable us to compete in terms of exports of goods and services, in terms of tourism and in terms of attracting foreign direct investment. Therefore any policies pursued by government (which has the responsibility for fiscal policy) or the Central Bank of Malta (in whose hands our monetary policy is entrusted) to curb inflation must be seen as good policies.
However, it is only possible to curb inflation if there is a concerted effort to allow the market to operate as freely as possible, in terms of prices. Equally important is the need to control businesses benefiting from monopolistic market conditions and who can therefore adopt pricing policies that would be detrimental to the competitiveness of Maltese firms.
A third aspect is surely the containment of labour costs and the tying in of increased wages to productivity gains. On this basis it starts to become possible for Malta to enjoy lengthy periods of low inflation.