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!