The Malta Independent
The external value of the currency is the flavour of the month on the political circus. Each Sunday morning the Prime Minister includes in his ritualistic sermon in some PN club somewhere, strong assertions that the mere idea of devaluation is economic blasphemy and that his government will not even give a second thought to the matter, sure as it is that our economy is on the mend under its own steam, aided by the measures taken in the 2005 budget.
If the Central Bank tolerates higher domestic inflation it is economically hazardous to try to address the excessive inflation through a fixed nominal rate of exchange which tends to get progressively more out of line, with its true underlying value threatening, as it is doing, the international competitiveness of Malta Inc.
For me, the issue of the need to address the over-valuation in the real rate of exchange of our currency is not the flavour of the month. I have been arguing in favour of serious discussion on the matter since early in 2001 when the real over-valuation shot from six per cent to 12 per cent in the space of a few months.
On 2 March 2001, in this same column, I commented as follows in a contribution titled Prognosis without prescription, following a business breakfast addressed by the Governor of the Central Bank:
“During last week public breakfast talk Governor Bonello made up for half his former omission. The correct half was a frank and emphatic identification of the problem of living beyond our means with resulting chronic deficits in the public budget and the country’s balance of payment. Governor Bonello, welcome to the rank of Geremiah and Cassandra!
The missing 50 per cent was in the prescription for the identified malady. If the country is living beyond its means then it can only address the problem if it cuts back its life style to within its means.
One of the most effective ways of doing this is by using the devaluation tool. No other economic tool is more powerful and effective provided devaluation is accepted for what it is, a reduction in the country’s standard of living versus the rest of the world.
Rather than reject outright the devaluation tool the Governor should have underlined that this would only be really effective and lasting if it forms part of a national economic re-structuring package which wins the support of the unions. This would avoid wage claims which would turn devaluation into an inflationary spiral requiring further devaluation. Rejecting devaluation outright is indicative of absence of real determination to tackle the problem until a crisis forces us to the unavoidable.”
Nearly four years after I wrote this and several similar contributions since then, it is certainly not too early to open serious consideration of using the rate of exchange policy to address the chronic faults which have developed in our economy. Hopefully, it is not too late either.
The external value of the currency is the flavour of the month on the political circus. Each Sunday morning the Prime Minister includes in his ritualistic sermon in some PN club somewhere, strong assertions that the mere idea of devaluation is economic blasphemy and that his government will not even give a second thought to the matter, sure as it is that our economy is on the mend under its own steam, aided by the measures taken in the 2005 budget.
It matters not in the least to our
Prime Minister that surveys show that the large majority of the population is
not at all convinced that the budget makes any significant contribution to
addressing our economic ills.
Just as predictably, the leader of the opposition blesses our Sunday new bulletins and Monday morning papers with explanations about the difference between devaluation and depreciation and asserts that the latter will have no adverse impact on the cost of living.
This would be comic if it weren’t tragic. I strongly advise both the Prime Minister and the leader of the opposition to stop this charade and find some other flavour of the month on which they can speak with better authority. Then if both of them truly have the strong views they express on the rate of exchange issue, they should meet quietly face to face with their economic experts and argue the case away from the headlines.
Otherwise, public discussion of this very sensitive and important issue will unavoidably lead to a hardening of the respective positions, making it difficult for parties to adjust their position following an objective review of the situation aided by some qualified, expert and independent advice from international sources.
The last source for such advice should be the Central Bank ofMalta
Chart 5.4 on page 43 of the September 2004 CBM Quarterly Review explains why. The Central Bank is charged with ensuring that our domestic inflation remains low and does not exceed that of competing countries. Because the Central Bank has failed to do so over a considerable number of years, during which interest rates were kept low to accommodate excessive government borrowing, our inflation has quite consistently exceeded that of our competitors. Consequently the real value of the Maltese lira rate of exchange was as at last July 11 per cent higher than it was in its 1995 base.
With hefty price increases in the pipeline for utility bills and public transport, among others, it is logical to assume that the inflation negative differential will continue to widen and the over-valuation in the real rate of exchange will continue to harden.
When the Governor of the Central Bank occasionally makes the point that their primary tool for the control of inflation is the defence of the fixed rate of exchange peg against the chosen basket of currency, he is missing the point that the objective ought to be the stability of the real not just the nominal rate of exchange.
Just as predictably, the leader of the opposition blesses our Sunday new bulletins and Monday morning papers with explanations about the difference between devaluation and depreciation and asserts that the latter will have no adverse impact on the cost of living.
This would be comic if it weren’t tragic. I strongly advise both the Prime Minister and the leader of the opposition to stop this charade and find some other flavour of the month on which they can speak with better authority. Then if both of them truly have the strong views they express on the rate of exchange issue, they should meet quietly face to face with their economic experts and argue the case away from the headlines.
Otherwise, public discussion of this very sensitive and important issue will unavoidably lead to a hardening of the respective positions, making it difficult for parties to adjust their position following an objective review of the situation aided by some qualified, expert and independent advice from international sources.
The last source for such advice should be the Central Bank of
Chart 5.4 on page 43 of the September 2004 CBM Quarterly Review explains why. The Central Bank is charged with ensuring that our domestic inflation remains low and does not exceed that of competing countries. Because the Central Bank has failed to do so over a considerable number of years, during which interest rates were kept low to accommodate excessive government borrowing, our inflation has quite consistently exceeded that of our competitors. Consequently the real value of the Maltese lira rate of exchange was as at last July 11 per cent higher than it was in its 1995 base.
With hefty price increases in the pipeline for utility bills and public transport, among others, it is logical to assume that the inflation negative differential will continue to widen and the over-valuation in the real rate of exchange will continue to harden.
When the Governor of the Central Bank occasionally makes the point that their primary tool for the control of inflation is the defence of the fixed rate of exchange peg against the chosen basket of currency, he is missing the point that the objective ought to be the stability of the real not just the nominal rate of exchange.
If the Central Bank tolerates higher domestic inflation it is economically hazardous to try to address the excessive inflation through a fixed nominal rate of exchange which tends to get progressively more out of line, with its true underlying value threatening, as it is doing, the international competitiveness of Malta Inc.
For me, the issue of the need to address the over-valuation in the real rate of exchange of our currency is not the flavour of the month. I have been arguing in favour of serious discussion on the matter since early in 2001 when the real over-valuation shot from six per cent to 12 per cent in the space of a few months.
On 2 March 2001, in this same column, I commented as follows in a contribution titled Prognosis without prescription, following a business breakfast addressed by the Governor of the Central Bank:
“During last week public breakfast talk Governor Bonello made up for half his former omission. The correct half was a frank and emphatic identification of the problem of living beyond our means with resulting chronic deficits in the public budget and the country’s balance of payment. Governor Bonello, welcome to the rank of Geremiah and Cassandra!
The missing 50 per cent was in the prescription for the identified malady. If the country is living beyond its means then it can only address the problem if it cuts back its life style to within its means.
One of the most effective ways of doing this is by using the devaluation tool. No other economic tool is more powerful and effective provided devaluation is accepted for what it is, a reduction in the country’s standard of living versus the rest of the world.
Rather than reject outright the devaluation tool the Governor should have underlined that this would only be really effective and lasting if it forms part of a national economic re-structuring package which wins the support of the unions. This would avoid wage claims which would turn devaluation into an inflationary spiral requiring further devaluation. Rejecting devaluation outright is indicative of absence of real determination to tackle the problem until a crisis forces us to the unavoidable.”
Nearly four years after I wrote this and several similar contributions since then, it is certainly not too early to open serious consideration of using the rate of exchange policy to address the chronic faults which have developed in our economy. Hopefully, it is not too late either.
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