mechanism are relevant in this context : one factor is exerting upward pressure on prices, namely, the continuing positive output gap ; while the other two factors are constraining inflation, specifically, the persistent deflationary mindset of the public and improvements in labor productivity. first, the output gap - - the factor exerting upward pressure on prices - - has remained consistently positive since the october - december quarter of 2016. in fact, the inflation rate and the output gap have been running in parallel with each other, with a certain time lag. this correlation indicates that the positive output gap has been acting as a factor placing upward pressure on prices. let me turn to the two factors constraining inflation. as for the first factor - - namely, the persistent deflationary mindset - - this cost - saving mentality has become deeply entrenched among consumers due to their experience of prolonged deflation, and has been influencing the cautious price - setting stance of japanese firms. in the formation of inflation expectations, the backward - looking expectation that reflects past inflation rates - - that is, the adaptive formation mechanism - - is more prominent in japan than the forward - looking expectation that reflects future economic conditions and changes in policy measures. this accounts for the persistent deflationary mindset. another factor constraining inflation relates to improvements in labor productivity, effects of which have been observed since around 2017. while the labor market is close to full employment, upward pressure on wages has not particularly increased. this is partly due to the fact that there was room for restraining wage increases as the labor force participation rate rose in parallel with the intensification of labor shortages ; moreover, it is worth noting that, with the anticipation of longstanding labor shortages, firms embarked on labor - saving investments, which in turn resulted in improvements in labor productivity. from the viewpoint of the output gap, a further widening of the gap within positive territory has been avoided by reducing labor input. improvements in labor productivity have prevented firms from passing increased costs, such as personnel expenses and raw material costs, on to sales prices ( chart 10 ). in other words, improvements in labor productivity have constrained inflation through the expansion in business fixed investment. b. outlook as the inflation mechanism has become more complex, it is not easy to forecast the outlook for prices. first, a positive inflation rate is necessary to overcome the persistent deflationary mindset grounded in the adaptive formation mechanism. assuming that the output gap remains positive, the

michael c bonello : opportunities and challenges of the euro for business speech by mr michael c bonello, governor of the central bank of malta, at the conference the transition to erm ii, emu convergence & euro adoption - implications for enterprises, organised by the malta business bureau and the mediterranean bank network, valletta, 15 october 2004. * * * the rationale for a common currency in addressing this topic it is first of all important to understand that the adoption of the euro marks only the last stage in a much broader process which started with accession to the eu. at that point, malta concurrently joined the economic and monetary union ( emu ), but its participation in emu is for the time being limited. in particular, malta has not yet entered erm ii. this means that both monetary and exchange rate policy are still under the control of the local authorities. this is in line with the ec treaty, which confers upon new members the status of member state with a derogation, allowing them considerable discretion as to how and when they should proceed towards the euro. such an approach builds on the premise that whereas a currency union offers the prospect of considerable benefits to its members, these can only materialise when a high level of convergence has been reached with the other participants in the union. when this point has been reached, a prospective new member is much less susceptible to asymmetric shocks, i. e. shocks which are not common to other members, and which would therefore require a monetary policy stance that differs from that which is appropriate to the currency union. the treaty ’ s provision for a flexible time - table is grounded in this fundamental economic principle. now, while most of us are probably familiar with the fact that malta has an obligation to adopt the euro at some point in the future, the rationale for doing so might be less obvious. perhaps an appropriate way to put it is that emu has come to play a central part of what the eu is today and of what it is expected to become in the future. this is because by significantly reducing transaction costs and intra - area exchange rate risk, the euro facilitates progress towards the completion of the single market and gives access to a large pool of financial resources. by increasing price transparency, moreover, the euro fosters a more competitive environment, which, in turn, is conducive to higher levels of efficiency. in this sense, the euro also contributes to the achievement of the lisbon strategy ’ s goal of