Curbing inflation for lower-income households

In a recent study, three Central Bank economists concluded that, compared to 2023, when most pensioners ended up either with a stable purchasing power or with a reduction, in 2024 all pensioners will be better off.

A recent Central Bank of Malta study looks at how the recent surge in inflation impacted lower-income households.

Three economists first define a new measure of inflation which is calculated based on the actual expenditure patterns of low-income persons and of retired households. These tend to spend less on things like restaurants and recreation and relatively more on food, medicines, and transport.

The recent surge in inflation was, unfortunately, concentrated in these categories, meaning that its impact on those on low incomes was stronger. Historically those earning the 20% lowest incomes have faced an inflation rate that was 0.2% higher than that of those earning the 20% highest incomes. However, in 2023 this gap peaked at 1.2%, due to the way price trends varied. In August the inflation rate affecting lower-income individuals was 5.2%, as against the official rate of 4%. The fact that food inflation is proving more persistent means that lower income households are taking longer to benefit from the slowdown in inflation. For retired persons, the recent surge in inflation was slightly more problematic, and their inflation rate at one point was 1.3% higher than that for the average household.   

The study points out how, between 2013 and 2023, those on the maximum pension saw an improvement of their benefits of 27.6%, whilst those on the minimum pension had an improvement of 50.3%. Before the surge in inflation in 2022, the study confirms that pensions kept up with inflation. In the more recent years, while those on minimum pensions maintained their purchasing power, those on the maximum deteriorated slightly.

The three economists find that, while in the Budget for 2023, Government introduced an additional COLA mechanism, the way it was determined excluded most pensioners. Thus, many, particularly those on the maximum pension, had to face higher inflation without being supported by this benefit.

Looking forward, the Central Bank economists assess whether, based on expected inflation, the increases announced in the Budget for 2024 – especially the refined additional COLA mechanism – will be enough to improve the purchasing power of pensioners. Their conclusion is that, compared to 2023, when most pensioners ended up either with a stable purchasing power or with a reduction, in 2024 all pensioners will be better off. Those on the minimum pension will be more than 5% better off in purchasing power terms than they were in 2021, while those on the maximum pension will be close to 1% better off.

It appears that the way the refined additional COLA mechanism works has benefitted pensioners greatly and will enable them to be more than adequately protected for future surges in the prices of food and other essentials.   

The study also looks at how the recent rise in inflation has hit those on the minimum wage, including households with and without children. Those without children saw an increase of 15.4% in income between 2013 and 2023, whilst those with children saw a 46.1% increase. The latter was nearly three times greater because the children’s allowance was increased and because of the introduction of the in-work benefit.

Up to 2021, increases were more than enough to compensate for inflation. However, that changed in 2022, when the COLA started to be lower than the actual inflation observed for lower-income groups. The additional COLA mechanism helped a bit, but its impact was limited by the way the formula for the increase was then determined. As a result, those on the minimum wage faced a loss of purchasing power in 2022 and 2023.

Three critical measures

The Budget for 2024 included three critical measures – the increase in the children’s allowance, the rise in the minimum wage, and the refinement of the additional COLA mechanism. The impact of these three measures on those on the minimum wage was very strong. As a result, parents on the minimum wage will be nearly 5% better off in purchasing power terms compared to 2021, with those without children being about 1% better off despite the high inflation they faced during these years.

The Central Bank study authors conclude that “although wages and pensions in Malta are indexed to inflation through the cost-of-living adjustment, minimum wages and pensions have still suffered some losses during 2021 to 2023 in their real value, with the exception of those on minimum pensions”. The main reason is that COLA is backward looking by one year, and these households have faced higher inflation than that indicated by the official Retail Price Index.

Yet, “in 2024, both pensioners and those on minimum wages are expected to have regained their losses in terms of purchasing power”. This reflects the fact that the COLA for 2024, the highest in history, will be given in a year in which inflation should ease considerably. Moreover, the Budget has introduced several measures such as the higher minimum wage, the increase in children’s allowance   and in-work benefits, higher pensions, and the modification of the additional COLA mechanism. The authors note that the new mechanism is now a top-up to the COLA for all those earning less than the median equivalised income. It is also based on “an estimate of the inflation rate computed on the basis of the consumption basket of retired or low income households”. As a result, it “should ensure that the effective purchasing power of retired and low-income households is protected better, and that any loss due to spikes in inflation are only temporary”.

It appears that Malta has managed to beat back the effects of inflation, one measure at a time. While inflation is now declining, the legacy of measures introduced – especially the refined additional mechanism against inflation – will serve us well in future years.

Photo: Kampus Production

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