by Vassilis Monastiriotis
The latest Interim Forecast by the European Commission makes some gloomy predictions for the Greek economy in 2012 but, interestingly, on the issue of inflation it states:
Constant-tax inflation in 2011 was 1.2% in 2011. However, for an economy in deep recession, the inflation rate reveals deep inflexibility in product and services markets. In 2012 the price rise trend is expected to be reversed, resulting in slight deflation of 0.5%. The main driving force stems from anticipated falls in disposable income and consumer spending due to wage cuts in the private sector.
(added emphasis is mine; the repetition is theirs!)
It is of course a positive sign, that the economists at the Commission have come to realise what ‘any fule kno’ in Greece: that downward price rigidities in the country are immense. Perhaps in the future they may make the additional step and come to realise that, by implication and given the sizeable reduction in nominal wages in 2011, inflation in the country is not (predominantly) driven by wage pressures.
But what is more startling in the text quoted above is the anticipation of deflation in 2012. This is based on a very simple principle of (neoclassical micro-)economics: the decline in disposable incomes shifts the demand curve to the left and the economy adjusts reaching a new equilibrium at lower prices (and lower consumption). So prices fall. And this is deflation! [Add to this the market deregulation measures (licensed professions, wage bargaining, and all that) and we get an extra fall of prices, through the outward shift of the supply curve – although the Commission report does not seem to make much of this (just a quick comment on “medium-term” effects).]
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