04–JANUARY 2013

MONTHLY NEWSLETTER SpotNomics

Department of Economics
Content Editor: Dr. E. Azzopardi Inflation
Inflation, as measured by the harmonized index of consumer
Contributor : Mr Victor Calleja
prices (HICP), is the instrument used by the EU to compare in-
This Issue flation rates among its members.

In 2011 the annual HICP inflation averaged 2.4 % compared

with 2.0 % in 2012. The average inflation rate moderated to-
wards the end of the year. Indeed, the year-on-year inflation rate
Great Economic Thinkers followed a generally downward path, reaching its lowest level in
December at 1.3%.
Inflation
Examination Success Prices rose at a slower pace in Malta than that in the euro area
during most of the 2011.
Inflation—Q & A
The increase in Malta’s average inflation rate between 2010 and
Great 2011 was mostly influenced by food prices. Nevertheless, energy
Economic remains the highest contributor to overall inflation, adding 0.8
Thinkers point to the year’s inflation rate. It averaged almost 12%, during
2011. Following the previous year’s liberalization measures en-
Paul Samuelson ergy price inflation in Malta reflected more closely that in the
euro area as a whole.
Paul A. Samuelson was the first American Nobel
laureate in economics (1970) and the foremost Source CBM Annual Report 2011, P 51
academic economist of the 20th century. He sur-
rounded himself with students and colleagues
such as Robert Solow, Paul Krugman, Franco
Modigliani and Joseph E. Stiglitz. HAPPY NEW YEAR
Prof Samuelson wrote a widely used textbook
called ‘Economics’. It introduced generations of
students to the revolutionary ideas of John May-
nard Keynes, the British economist who in the
1930’s developed the theory that modern market
economies could become trapped in depression.
He said that this situation would need a strong
push from government spending or tax cuts, in
addition to lenient monetary policy to restore the
economy.

Samuelson was also one of the economic advis-

ers to the American president J.F. Kennedy. His
advice to cut taxes, since the economy was head-
ing into a recession, was accepted by Kennedy
who was assassinated before he could take ac-
tion. His successor, Lyndon B. Johnson carried
out the plan and the economy bounced back.
One of Samuelson’s early works presented a uni-
fied mathematical structure for predicting how
businesses and households alike would respond
to changes in economics forces, how changes in
wage rates would effect employment and how
tax rate changes would effect tax collection.
Samuelson died at the age of 94.
Source: Wikipedia
Examination Success
All essays must have a conclusion.
What is a bad conclusion in an economics essay?
• Repeating the essay title
• Summarizing the essay
• The wrong conclusion
What is a good conclusion in an economics essay?
• An application within the Maltese, European or world context
• Applying Maltese statistical information
• Reference to the development of the arguments
 Inflation—Q & A
To measure overall inflation, the price change of a large ‘basket’ of representative goods and services is
measured. This is the purpose of a price index, which is the combined price of a ‘basket’ of many goods
and services.
Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in
the way in which goods and services from the present are compared with goods and services from the past.

Important definitions of inflation

• Inflation is a process of persistent rises in the general level of price. .
• The rate of inflation measures the annual percentage increase in prices over a period of time.
• The annual percentage rate of inflation is calculated by:

GDP (current year) - GDP (base year) x 100

GDP (base year)

What are the general effects of inflation?

An increase in the general level of prices implies a decrease in the purchasing power money. That is, when the aver-
age price level rises, each monetary unit buys fewer goods and services. Also, the effects of inflation are not distrib-
uted evenly in the economy and as a consequence there are hidden costs for some and benefits to others.

What are the negative effects of inflation? What are the positive effects?

High and unpredictable inflation rates are regarded
as harmful to an overall economy. They add ineffi-
ciencies in the market, and make it difficult for
companies to budget or to plan long-term. Uncer-
tainty about the future purchasing power of money
discourages investment and saving. With high in-
flation, purchasing power is redistributed from
those on fixed nominal income, such as pensioners,
towards those with variable incomes whose earn-
ings may better keep up with inflation.
High inflation can prompt employees to demand
rapid wage increases to keep up with consumer
prices. In the cost push theory of inflation, rising
wages in turn can help fuel inflation. Inflation can
also lead to massive demonstrations and even revo-
lution. Food inflation, for example, brought about
the Tunisian and Egyptian revolutions in 2011.
Hyperinflation is a term used when inflation gets
out of control (in the upward direction). It can
grossly interfere with the normal working of the
economy, hurting its ability to supply goods.
Also, with inflation, lenders and depositors who are
paid a fixed rate of interest on loans or deposits
will lose purchasing power from their interest earn-
ings, while their borrowers benefit.
We know that nominal wages are slow to adjust
downward. This can lead to prolonged disequilib-
rium and high unemployment in the labour market.
Since inflation allows real wages to fall even if
nominal wages are kept constant, moderate infla-
tion enables labour markets to reach equilibrium
faster.
Also, if an economy finds itself in a recession with
already low, or even zero nominal interest rates,
then, the central bank cannot cut rates further in
order to stimulate the economy. The situation is
known as the liquidity trap. So a moderate level
of inflation tends to ensure that normal interest
rates stay sufficiently above zero so that when the
need arises the central bank can reduce the nomi-
nal interest rate.
Various economists observe that moderate infla-
tion, once its expectation is incorporated in normal
interest rates, would give those interest rates room
to go both up and down in response to shifting
investment opportunities, on savers’ preferences
and thus allow financial markets to function in a
more normal fashion.
Source: Wikipedia+