Last week, the government published the inflation report, in line with what the Minister of Finance had promised in the last Budget. This report is also in partial fulfilment of an electoral promise made by this government to exercise a stronger oversight over price movements in Malta.

The report in itself is very interesting and informative. It opens a window on one of the most important economic indicators. Students of economics have had to ponder for long hours on the causes and effects of inflation and on the extent to which inflation may be positive for an economy.

The significance of inflation as an economic indicator is best exemplified by the fact that central banks have, as one of their two main objectives of monetary policy, price stability (the other being exchange rate stability).

Central bankers are also known to be very averse to inflationary pressures on the economy to the extent that interest rates are changed in response to such pressures, even though they may not be actual but only expected. The destabilising influence of inflation has long been known, but things came to a head in the 1970s when inflation and unemployment started to move in the same direction instead of opposite directions.

Up to that time, inflation was seen as a necessary evil if one wanted to maintain full employment. Up to that time the fear of deflation was far greater than the fear of inflation. From then on, we got to know the term “stagflation” which means stagnation and inflation at the same time, and inflation stopped being so necessary to generating inflation. Economists had come to realise that inflation and the fear of even greater inflation brought about so much uncertainty that it could not possibly lead to an increase in employment.

So the control of inflation became a key policy for governments, and some countries have seen their economy crumble because of runaway inflation.

One important aspect of the inflation report published by government is the data relating to core inflation, which measures inflation, but excluding the influence of certain items that face volatile price movements.

It is interesting to note that the level of core inflation in Malta has hovered around the 1.5 per cent mark since the end of 2007. During this period, headline inflation reached a peak of nearly 4.5 per cent in mid last year. This indicates the strong impact that international prices have on our inflation rate and the vulnerability of our economy to international price movements.

What does the future hold for us in terms of inflation? Although the EU economies have been showing signs of economic recovery through an increase in exports, this has yet to feed into investment.

The expectation is that investment will only start to increase next year. This has had as a consequence the subdued performance of the labour market and labour costs pressures are generally very much contained. Thus inflation remains low – less than half the rate registered two years ago in 2008.

Next year, very little movement is expected in the inflation rate within the EU and especially the eurozone area.

However, the story may differ from one country to another, given national fiscal policies and the labour market situation. The policy of fiscal consolidation that government is expected to take in the next budget and the spare capacity in our economy is unlikely to lead to any inflationary pressures.

On the other hand, the expected weakening of the euro in conjunction with price increases of imported products (mainly energy products) and some tightening in parts of the labour market could create some expectations for an increase in inflation.

So there is still a great level of uncertainty with regard to how inflation may develop in Malta in 2011 and 2012. Meanwhile, the story continues.