Stagflation is not a Virus

According to Eurostat, at 4.2 per cent, Malta has reached the highest inflation rate in the eurozone and the second highest in the whole European Union. In fact, it is almost double the average in both cases.

In economics, inflation can be considered as a Hydra, a multi-headed beast which once it inserts itself is so difficult to dislodge. It hurts our economy in a significant way. First of all it reduces our purchasing power by the same rate of the inflation.

The worse-off are those segments of society on fixed incomes such as pensioners. Year-in year-out inflation gnaws at one’s precious savings like a hidden rodent. Diligent savers and lenders are thus heavily penalised. Not so the spendthrift, the borrowers and the debt ridden whether as private individuals, companies or government. These are rewarded for their largesse: a gross injustice giving perverse signals.


Our tax system is such that even if those previously untaxed pensioners and wage earners were to have their incomes compensated by the cost of living adjustment (COLA) system, they could start appearing to the taxman to be earning more and are thus caught in the tax net, even though in reality they have not had an iota change in their real incomes.

With higher prices and a fixed exchange rate, exports of manufactured goods and services such as tourism start losing their competitiveness and bring about unemployment.


The only gainer is the government. Inflation rakes in more revenue and, by inflating its GDP in nominal (though not real) terms, it sees its national debt to GDP ratio falling. No wonder that the government is maintaining its silence in the face of rising inflation.

What is strange to many is that inflation is peaking just as we are in the midst of a recession. There are clear indications that Malta will carry on with its recession well beyond the technical two quarters, in which case we are experiencing not just inflation but stagflation.

Those students who were brought up with a strict diet of Keynesian economics were given to understand that economic cycles are represented by economic booms at their peaks and economic recessions and unemployment at their troughs. Thus, inflation and a recession were right opposite each other’s side of the cycle.

By using the fiscal policy tools encouraged by Keynes, governments used to be advised that they could aim for less unemployment but, in so doing, have to accept higher inflation. On the other hand, if they wanted to fight inflation they had to accept higher unemployment. This trade-off was even epitomised in practice at the time by Phillips who named the curve after him.

Governments thought they were presented by an a la carte menu of choices. Germany, in fact, due to its historic fear of inflation, opted for zero tolerance to inflation but had to accept some unemployment. On the contrary, Britain, again for historic reasons, was allergic to high unemployment but tolerated higher inflation.

This economic balance was blown in the early 1970s in theory and practice and the word stagflation was coined. It represents a situation where a country can experience high inflation even during a recession. That reality is here today.

Our country and others elsewhere have legally set up an independent institution tasked with the responsibility to monitor, protect and contain this hated economic monster.

That institution is the Central Bank of Malta. While it was salutary that the CBM Governor has spoken out and confirmed our concerns about the government’s fiscal slippage during this year, we have yet to see a statement about inflation in our country. If our monetary tools have been shipped to Frankfurt the responsibility to monitor and speak out is still with us.

We need to know what is fuelling this inflation. What is the forecasted outlook in the short and medium term? What can we do about it?

If the authorities do not answer these legitimate questions then expect to continue hearing all sorts of nonsense where any price change in the market is labelled inflationary, where we will continue groping in the dark not knowing whether property prices are on an upward or downward trend, where the trade unions will start asking for justice to be done for their members, where a frightening spiral might ignite. Our economic problems will then become that much more difficult to solve.

As for my own hunch, I believe we are living in a divergent two-speed economy, a sort of twin economy where the private sector is at the moment going one way (down) and the public sector another way (up).

The eurozone’s recession coupled with our high inflation are depressing the manufacturing and the retailing sectors and supposedly local prices as well. However, at the same time, the public sector, with its ridiculously self-imposed political cycle, has underutilised the EU funds for the last five years of the EU financial framework so it can splurge on public projects and related incomes during the last year before the election.

In fact, graphically, the inflationary cycle fits in perfectly with the political and fiscal cycle. All these rushed works are showing that all the leftover millions of EU funds are chasing a small number of contractors, goods and services in a very short period of time. The dictum that inflation is money chasing a few goods has never been truer than today.

Stagflation is not an economic virus we got from abroad. It is the result of bad economic governance. Who mentioned a safe pair of hands?



– : Wednesday, 5th September, 2012


Leave a Reply

Your email address will not be published. Required fields are marked *