Are Markets Expecting Greece To Leave The Euro?

I still can’t get my head around this: Greece’s inflation rate (HT @global-rates.com) has literally been soaring in the last 18 months although the economy never really exited recession. As Edward Hugh’s PMI graph shows, demand in the Greek economy has been faltering thoughout 2010. In other words, the recession is still as strong as it was in early 2009, when people all over the world were drawing up comparisons between this global recession and the Great Depression of the 1930s. Meanwhile, inflation in Greece is higher now than in 2008, when oil prices temporarily hit €90 per barrell (now they’re at €75).

Standard (New Keynesian) macroeconomic models tell us that a fall in demand like in Greece now should lower inflation rates. Inflation rates should only go up during recessions if it is the ‘supply side’ that is contracting. The supply side usually consists of worker’s wages and input prices. Admittedly, input prices have increased worldwide due to higher commodity prices and, further, Greece experienced a VAT rise in 2010, which is known to increase prices somewhat. Nevertheless, against the background that the recession in Greece is on track to become a depression, can that suffice to explain this growing inflation differential to the other EU countries? (HT @greekeconomy.blogspot.com). I sincerely doubt that.

I propose a different explanation, namely a monetary one. Inflation can be caused by people dumping their cash holdings. They may do that in response to fears of future inflation or of currency devaluation. So, might it be that the Greek are dumping their cash (Euro, that is) in anticipation of a devaluation and subsequent inflation (which, of course, could only be the result of Greece leaving the Euro)? I shall try to check if any data about this is publicly available, so hold on for a follow-up post!


6 comments on “Are Markets Expecting Greece To Leave The Euro?

  1. Hi,
    interesting point, however consumption in Greece went through a severe contraction in 2010, as did investments. This resulted in a GDP drop of 6.6% in Q4.
    The main reason for th inflation hikes are indeed VAT plus other indirect tax increases which suppliers were able to pass on to consumers due to the extreme rigidities of product markets and quasi-oligopolistic structures which characterize the Greek economy.In contrast labor costs fell (slightly) for the first time since 1993

  2. Titos has put it in a nutshell. Government-ordered tax increases (yes its the Troika in the end) were a major component of the inflationary surge. But the cartelized structure of the economy, which is not being addressed, allowed for cost pass-throughs in many sectors and hence tax-driven inflation. Also, the black economy left large reserves of purchasing power which even now remain accessible, although to a smaller degree. Labor cost decreases were not seen anywhere…because the public sector is still receiving most of what it receivd in the past…wage cuts were symbolic.

  3. Duly noted, consumption is also in recession mode. However, consumption is decreasing with approximately the same rate as GDP, thus the consumption/GDP ratio did not change much yet. Given that the Greek economy was on a consumption binge in the last 10 years, one would expect the ratio to decrease to more sustainable levels, so consumption should decrease more than GDP. The fact that it did not, although tax increases were burdened overwhelmingly on the consumers, could support the thesis that people consume more than they should/would otherwise.

  4. I’m glad we have a Greek here to tell us the ground truth. Thanks Titos, and thanks Alec.

    It’s a crying shame that the legacy of the birthplace of democracy, the philosophy of Athens, and the martial prowess of Sparta is a Marxist dystopian horde of lazy whiners. Greece needs to shed its socialist bonds and become the great nation it used to be.

    I had the honor and privilege of serving with Greek soldiers in Kosovo. They were fine examples of the best of Greek society.

    BTW, I hope you will comment on the recent story about honoring Ronald Reagan in Berlin.

  5. You can find here a pretty good account of current economic development in Greece:


    There are no figures as yet, though estimates indicate that private consumption contracted at approx. the same rate as GDP (4.5%), but public consumption (and investment) at much higher rates. There was also a shift in the external balances: exports grew, imports fell. Private consumption probably fell faster than GDP in the last two quarters of 2010.

    I am not sure that private households were significantly overleveraged in Greece prior to the crisis (in contrast to the State), so I’m not sure whether private consumption can, indeed, fall faster than GDP -though bank deposits are declining, which means people are using up savings to consume (and to transfer funds abroad).

    Greece is in danger of falling into a vicious cycle of depression, because the government has failed to implement structural reforms to stimulate the supply side while squeezing demand; and is taxing the private sector effectively out of existence, while fighting a rearguard campaign to protect privileges of unions and various organized interest groups. It has also taken no real action to fight tax evasion and corruption, while privatizations remain, for now, a pipe dream.

    Personally and regardless of what happens at EU level with the debt, I don’t think the Greek economy will revive in any significant way this decade -unless there is some miracle complete break with the past.

    • “Greece is in danger of falling into a vicious cycle of depression”

      That is true indeed. In fact, it is already happening as growth rates plunge quarter after quarter. Once deflation takes hold, which seems only a matter of time, nominal GDP will shrink by 10-20% y-o-y. That will probably break the neck of Greek banks and consumers. There are only two options left to prevent this from happening: a) Leaving the Euro, or b) Debt forgiveness by Europe. Both have to happen soon (within the next 6 months), which does not seem likely. As such, The outlook for Greece is indeed dire.

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