Greece has shown us how consumer and producer inflation combined with wage deflation is a toxic mix

I wish today to look at the situation in Greece and to explain that during its current crisis it has a problem which conventional economic theory would have told us was virtually impossible. Indeed such theories are still about for example I quoted in my article on Wednesday this excerpt from a speech by David Miles who is a member of the UK Monetary Policy Committee.

My view – shared by my colleagues on the MPC – is that there is a margin of spare capacity in the UK economy which has been, and will continue, depressing domestically generated inflation pressures.

If you change the UK for Greece and you pursue such a theory you will project the following. Firstly that there is an extraordinary output gap following the economy’s acceleration downwards which in 2011 was of the order of 7% which came on top of a 5% fall in 2010. Accordingly you would conclude that there must be heavy downward pressure on domestically generated inflation. Indeed it would not seem unreasonable to think that we should be seeing not only falls in inflation but outright falls in prices or what I call disinflation.

Reality in Greece is somewhat different from such theories

From her statistics agency yesterday.

The Producer Price Index in Industry (PPI) in February 2012 compared with February 2011 recorded a rise of 6.8%.

Certainly not what the theory above would make you expect or predict is it. And if we look further into this report we see that such a situation has been persistent over her recent crisis.

The index in February 2011 had recorded an increase
of 8.5% compared with February 2010.

Still the current severe economic squeeze must be having an impact right now mustn’t it?

The PPI in February 2012 compared with January 2012 recorded a rise of 0.7%.

If we look at the underlying index for producer prices we see something disturbing and is what would be called contra-cyclical. The index is based on 2005=100 but in 2010 it was 118.8 so that we can see that between 2005 and 2010 when the Greek economy had a good spell before its downturn we saw relatively little producer price inflation whereas we then went 2011, 128.9 and 2012, 137.6. So it has surged as the economy has collapsed! We can see quite a few economic theories collapsing here too.

What about Consumer Inflation?

Here we see a pattern that pre-credit crunch would have been expected by very few. In such an economic collapse one would using the theories still believed apparently by Davd Miles and others think that Greece would have such heavy downward pressure on domestic inflation that she would have disinflation.

Let us take a look at the figures

The Harmonized Index of Consumer Prices (HICP) in February 2012 compared with February 2011, increased by 1.7%. In February 2011, the annual rate of change of the HICP was 4.2%

For those unaware the HICP is the European Union standard measure of inflation and the UK equivalent is called CPI. So in 2011 Greece had an element of a consumer inflation problem and it is still 1.7%. At this point any output gap computer programme is likely to be behaving like HAL as it approached Jupiter in the Film 2001 (when it realised it has been lied too…).

Actually you could easily argue that “output gap” analysis worked better in 2009 when HICP fell below 1% but then you have the problem that output was much higher then. If you were about to go out into space in a pod it might be best not to make HAL aware of that! Even less the surge to above 5.5% in the late summer of 2010.


At this point in the story I simply want readers to consider the implications of an inflationary episode when an economy is contracting and in this instance has fallen into an economic depression.

What about wages?

These have lagged behind this and we are going to see them fall further. The European Commission’s analysis of the latest Greek bail out told us that on its measure of nominal unit labour costs had fallen from around 140 at the start of 2010 to 130 now where 2001 =100. So already we get a picture of falling wages. The latest figures for Greek unit labour costs from the European Central Bank have them falling by 3.6% in the year up to the third quarter of 2011. If we go backwards by quarter we see -0.4%,-7.3%,-4.9%,-3.9% and -4.7%.

What can we expect now?

The European Commission document starts off with euphemisms but then becomes rather explicit. At first we get this.

helped some firms to adjust their labour costs…….to allow wages and hours to adjust faster…….ensure the quick responsiveness of wages to the fall in economic activity……The downward wage flexibility.

Then we get some outright statements and numbers.

The authorities and the mission staff discussed and agreed on a package of actions to be taken by the Government in the short term, which should contribute to reduce labour costs in the business sector by 15 percent over the programme horizon.

And the cuts to the minimum wage in Greece which did at least receive a modicum of publicity.

The wage floors in the National General Collective Agreement (NGCA) have been reduced by 22 percent, or even by 32 percent for those younger than 25.

Perhaps grim enough in itself but then take a look at something which was reported much less.

This is important as the level of minimum wages and of other wages regulated by NGCA became more binding as the average wage declines. Thus, the reduction in the minimum wage creates additional room for downward wage adjustment

All this comes on top of a situation where wages have fallen substantially. The economist Rebecca Wilder recently calculated that average monthly earnings in Greece fell by 18.7% in 2011.

Such numbers need some care as commenters to this blog have pointed out some wages in Greece are delayed heavily or are not paid at all. I would be interested in an update on this situation.


This is the equivalent of “Houston we have a problem!” to much pre credit crunch economic theory. The inflation pattern shown in Greece would never have been expected if you saw the pattern of her economic output.

There is also a nuance which some economists use as an attempt at a get-out clause. This is that some of the rise in consumer prices is due to the rise in indirect taxes. For example Greece has seen rises in Value Added Tax and excise duties which have raised consumer inflation.

However my concentration today is on the ordinary Greek citizen. As he or she goes to the shop and buys their groceries all they are concerned with is that they have to pay a price. On average their wages are lower and if the European Commission gets its way then they will go lower still. Yet they still face price inflation which at the producer price level is still considerable.

1. On these trends how are we going to see an improvement?

2. Yesterday I pointed out that debt in Greece was in effect being kicked into the future and it would be harder to repay it rather than easier on current trends. Well today I wish to take this further and apply the analysis I used on the 24th of February.

Take a Greek citizen seeing falling wages and rising prices. They will see more and more of their money going on essentials such as food,housing and fuel. Accordingly less and less would be available to pay off any debt unless your plan is to cut back on the three items I have mentioned….

Wouldn’t your devaluation plan have similar effects?

Not quite as it is the order of events that matter. In a devaluation competitiveness improves there and then and any inflation comes later. The economy may not spring out of the blocks like Usain Bolt but the response should be quick.

However the Euro “internal devaluation” route has ended up with inflation first as it has dithered andso competitiveness takes another knock. So they have ended up on a road which looks ever harder. Ironically the European Commissions criticism of Greece is an implied criticsm of itself too.

did not deliver a strategy to quickly address the large challenges Greece is faced with.

Unfortunately self-awareness is not one of the European Commissions strengths.

Update: Greek retail sales

Just after I wrote this post these were released and what a grim tale they tell.

The retail trade volume index, including automotive fuel, decreased by 10.3% in January 2012 compared with January 2011. The Index in January 2011 recorded a decrease of 16.1% compared with January 2010 .

For those who follow the underlying index then it is now at 79.6 where the base is 2005=100.




This entry was posted in Euro zone Crisis, General Economics, Greek Financial Crisis, Recession, Stagflation. Bookmark the permalink.
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  • Anonymous

    Shaun – most insightful. I read today that Mr. Papademos is suggesting that a third bail-out may well be on the cards as “nobody can foresee the markets in 2015″. For the average Greek citizen this means, in my opinion, that they can look forward to a further decimation of their standard of living; meanwhile the EZ continues to promote medicine known not to cure. On a lighter note I have just read the following on the “Open Europe” news:
    “EU officials working in EU Council President Herman Van Rompuy’s office have created an unofficial press release suggesting that the Vatican should be invited to the next Eurozone summit because “The presence of His Holiness the Pope affords an opportunity to pray for divine intervention to save the euro. This is now seen as the most credible strategy.”

    I say no more……

  • Andy Zarse

    Hi Shaun a good analysis of the failings of current economic theories, as being implemented in the Eurozone. Theories are one thing, the reality is how it affects the lives of ordinary citizens. It seems a gratuitously cruel experiment with youths and pensioners playing the roles of the lead laboratory rats. I just wonder how long it is until the rats wake up and make good their escape?
    Talking of inflation, I guess you’ve seen the excellent article on the subject this week from your blogosphere nextdoor neighbour Simon Ward?
    “In a Guardian interview a year ago the MPC’s leading dove, Adam Posen, predicted that inflation would tumble to 1.5% by the middle of 2012 and stated that: “If I have made the wrong call, not only will I switch my vote, I would not pursue a second term.” Will Dr. Posen honour his pledge or try to shift the goalposts by appealing to economic weakness or claiming his forecast was blown off course by yet more “one-off” shocks?”
    I like Simon’s use of the term “economic weakness” meaning more inflation, I guess he sees things the same way as you! H But, has Posen got any “wriggle room” do you think, or will he be bidding us, the MPC and his index linked pension au revoir?

  • MajorFrustration

    Am sure you have already thought of some economic themes for your 1st April Blog but have you considered presenting a chronology of the funding expectations of the EFSF since inception allied to what has been raised and distributed todate. Understand that the latest capital amount is E800bn LOLOLOL

  • JW

     Another nice quote from Simon;
    ‘The sustained UK inflation overshoot was predicted by a monetarist
    forecasting approach, as detailed in previous posts here. The Bank of
    England either has the wrong model or is deliberately contravening its
    I think we know which it is.
    Netherlands starting to edge towards the ER. Still Germany has lower unemployment, must be worth it all then……

  • JW

    Hi Shaun
    In a somewhat round-about way Ford’s decision today to invest 1.3BN in a Mexican plant to produce new models for N. America sums up the situation. Globalisation determines the investment of multi-nationals, the only entities with ‘real’ money. Jobs will go in the US, cheaper labour will produce the goods sold the US customers through cheap loans made cheap by QE. And so it goes around.
    The very same people who ‘benefit’ from the cheap loans, pay for them eventually though taxation, they lose jobs, their kids lose jobs. The Mexicans also suffer because their economy continues to only produce low cost labour jobs.
    Who ‘wins’? a very few people who benefit from Ford’s ‘success’.
    Welcome to the continuing development of a stark bi-polar world. 

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  • Anonymous

    Hi Ray

    Is the last bit an early entry for an April the first edition or reality? Sometimes these days it is really hard to tell…. :)

    Also if Mr.Papademos can forsee that markets before 2015 perhaps he might let the rest of us in on it!

  • Anonymous

    Hi JW

    The debate over the power of multinationals has gone quiet in the past couple of years but their relative power has risen as governments have weakened. For a start if we look at the UK and US it is larger companies who have cash with Apple being the most famous example. Although we have ZIRP we may well see a “cash is king” phase.

    Japan has been another case of exporting an exporting industry and I await to see how that plays out. It was bad luck for them when Thailand had the floods adding to the 2011 theme of natural disasters affecting Japanese industry. But whilst it retraced a little last week  the Yen appears to be in a weakening phase so it may be watch this space.

    If we stick to the Euro theme the country most vulnerable to multinational power is Ireland.

  • Anonymous

    Hi Major

    The problem with an April the first update on the Euro Major is how will people tell that it is humour…..?

  • Anonymous

    Hi Andy

    I doubt will be surprised to read that I had remembered that quote from Adam Posen. In terms of wriggle room he may be able to push the dates to September as that is when he usually gives his key note speech for the year.

    In terms of using alternative inflation indices he would be on very weak ground as he has used and then dropped virtually all of them. So the only option remaining here would be to construct his own!

    How many “one-offs” can there be?

  • Anonymous

    Actually in terms or Simon’s quote about the Bank of England the recent model chage I talked about in my review of the speech by David Miles means that I think both were at play.

  • Anonymous

    Iceland took about 3 years after default before it was able to return to the markets. Greece should copy Iceland’s default and then it might be able to return to the finance markets before Dec 2015 ….