Has price stability gone hay wire?

By Kurt Sansone

An analysis carried out by The Malta Financial and Business Times on the change in the Retail Price Index (RPI) on a year-on-year basis reveals a rise of more than 2% for the last four months, indicating a lack of price stability in the Maltese islands when compared to criteria adopted by the European Central Bank.

Similar to its Maltese counterpart, the European Central Bank has put price stability as its primary monetary policy objective. In 1998 the ECB defined price stability as a "year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%." The HICP is a harmonised retail price index for the euro area similar to the Maltese RPI calculated by the National Statistics Office.

If one were to apply the ECB criteria for price stability to the Maltese context the results for the last four months are not encouraging.

The year kicked off well with the January price index rising by 0.63% well within the ECB criteria. The same positive momentum was maintained in February and March when the increases were 1.07% and 1.47% respectively.

However, the situation took a turn for the worse in April when the price index increased by 2.45%, which is above the ECB’s 2% criteria. The negative momentum continued in May and June when the RPI increased by 2.60% and 3.13% respectively. The latest results for July show that the negative trend was maintained and the RPI increased by 3.55%.

Despite this persistent negative trend in price stability last week the Central Bank’s monetary council decided to lower interest rates by 25 basis points. The discount rate now stands at 4.5%.

The Council stated that it arrived at this decision after considering recent international and domestic economic and financial developments. It must be noted that contrary to the ECB the Maltese Central Bank monetary policy strategy is based on exchange rate targeting. The Maltese lira is pegged to a basket of foreign currencies that is made up of the euro, the dollar and pound sterling.

Reacting to the Central Bank’s interest rate reduction, Labour spokesperson Leo Brincat criticised the move and described it as a measure to placate government’s debt problems.

Mr Brincat pointed out that similar decisions to reduce interest rates are taken when inflation is under control. Comparing the rate of inflation in July this year with that of last year, Mr Brincat concluded that contrary to what is happening in Europe and the US, Malta’s inflation continues to rise month after month.

Mr Brincat said that the inflation in the Eurozone is under control and this prompted the ECB to reduce its interest rates.

The Opposition spokesman added that the reduction in the base rate showed that the Central Bank was not the independent institution everyone expected it to be. "With this decision the Central Bank is departing from its policy to maintain price stability in our economy. In our opinion the Bank seems to be bowing down in front of government," Mr Brincat’s statement concluded.

According to the Central Bank’s monetary policy the main aim is to maintain domestic price stability, a necessary condition for sustainable growth in employment and incomes. The Central Bank web site does not define what price stability is, but when compared to the ECB criteria Malta definitely has a long way to go.