Discussions on the cost of living are quite common in our daily chatter. We are often surprised, if not critical, that the newscaster announces that inflation has decreased. How is that possible? We often wonder on how inflation could have gone down when prices seemed higher at the supermarket. So how does inflation work? Why do official statistics differ from the way we perceive inflation?
The inflation rate is not solely determined by those items we purchase daily from the corner shop but rather by a typical basket of goods and services purchased over a given period of time. The composition of this basket is reviewed periodically to reflect changing trends in consumer behaviour. The basket is, however, harmonised across the European Union so that the rates of inflation of each country in the EU can be compared with each other.
It is worth pointing out that it might be likely that the prices of frequently-purchased items such as groceries increase more often, generating the impression that the cost of living is always going up. Seasonal items like fruit and vegetables, for example, also vary considerably in price from month to month but the likelihood is that it is only when they are more expensive that we comment!
Increases in salaries, the improvement of quality through purchase of modern machinery and increases in the cost of energy all drive prices upwards. On the other hand, greater competition has resulted in a reduction in prices in sectors such as telephony (both fixed and mobile) and travel over the past few years, while the reduction in computer and household goods prices reflect the efficiency gains in production of technology. So indeed some prices do go down as well!
On the other side of the coin, inflation is also a reflection of an improving quality of life: more and better jobs, better wages and an increasing demand due to increased consumption. Thankfully, in Malta, we have a mechanism for wage compensation that makes good for any increase in the cost of living in the previous year.
Positively, it seems that Maltese consumers are very much abreast of developments in pricing trends. From studies carried out by the European Commission, based on the real and perceived inflation over the past few years, a clear relationship in the trends emerges. For example, the increase in real inflation between November 2003 and July 2005 and the decrease in inflation between the last months of 2006 and today are clearly reflected in the way the Maltese perceive the level of inflation. Nonetheless, the recent drop in inflation, since the beginning of the year, that has allowed us to reach the convergence criteria for euro adoption has not as yet been fully felt by Maltese citizens.
The European Commission, in accepting Malta to join the eurozone, has confirmed that, indeed, Malta's inflation has been running very close to the European average over the past years. Joining the eurozone, Malta's monetary policy will be managed by the European Central Bank, whose main aim is to maintain low inflation - a further guarantee of price stability for years to come.
Mr Zahra is executive, Technical Preparations, at NECC.