The effect of the Euro introduction on inflation in Malta

Abstract

Euro zone customers perceived higher price increases following the introduction of the euro as a national currency on 1st January 2002. This contradicted official statistics which proved that the impact of the new currency on price increases was quite modest. Due the effects of money illusion, the euro cash changeover was more than just a change in the scale value of money as it triggered changes in consumption patterns. Apart from this, persistent perceived inflation may lead to actual price increases in the long run. Given the experience of the first wave of the euro changeover, a model is implemented to test whether Malta followed the same trend as the other euro zone countries or whether the various measures undertaken both prior and also after the changeover to account against the effects of money illusion and any possible unfair price increases were successful. The model, which considers the RPI for Malta and other variables such as the introduction of the euro and any seasonality effects, tests the extent of the impact that each of these factors had on price increases. The model compares the prices of one month with the same month the previous year. This is done for two main reasons. Principally, the effect of the euro changeover is captured more since any effect recurring in consecutive months is eliminated and secondly, seasonal effects are alike given that the same month is being compared. The impact of the changeover resulted to be statistically significant. Nevertheless, the effect of the changeover on price increases was minimal.