Is There a Danger of Inflation in Greece - Essay Example

1 Introduction Greece, though small in area and population, has a big and ical history. The Greek mythology is as famous, thought provoking and interesting as the great Indian mythology. If you think of Greece, you will at once remember Alexander the Great who once ruled most parts of the world with reverence. But that was the golden past in the ancient times. The modern Greece has seen many ups and downs in its political and economic arenas and its convergence into the European Monetary Union (EMU) was preceded by a covert operation of its economic failures. There are allegations that the country provided false information on its economic performance between 1997 and 1999 to converge into the EMU with the observers hinting that its actual performance would not have allowed the country to join the euro zone ( Athens News Agency). Greece ultimately joined the Euro monetary area as its 12th member from January 1, 2001 after the European finance ministers' council decided on June 19, 2000 that the country had fulfilled all the convergence criteria and approved its accession (Micco et al, 61). Greece had a troublesome inflation history. In 1990, the performance of the Greek economy was very poor with the inflation reaching higher than 20% and the budget deficit exceeding 16% of the GDP. During that particular year, the growth rate was literally zero and the current account deficit was 4.3% of the GDP. The EMU project came as a blessing in disguise for Greece and throughout the 1990s, Greece implemented economic and political policies that were in tune with those of EMU (Greece in the European Union, 93). 2 This paper discusses the inflation trends and theories in general, and explores the Greek economic scenario briefly in particular with a view to finding out whether there is a danger of high level of inflation in the coming days in the country. A deep analysis of the economic factors guiding the inflation trends in Greece suggests that the Government economic measures will certainly help reduce the inflation threat considerably. Body Part A (Inflation theories) Before we proceed to assess whether or not an impending threat of high level of inflation is emerging in Greece, there is need to study the essentials of inflation on how it is caused. In any country, inflation is basically caused through the emergence of two powerful but common scenarios. Factors of inflation The two factors from which inflation stems are an increase in demand for products, known as the demand pull inflation and an increase in the cost of factors of production, known as the cost push inflation. Monetarists, also known as the neo-classical theorists, point out that when there is a surge of money supply in a nation's economy, it leads to excess money on an aggregate level and creates more demand by increasing the spending capacity of the population. To put it simply, inflation is created when the spending power of the population exceeds the capacity of a country 3 to produce goods and services in enough quantities. This is a situation where prices of commodities go on increasing with the supply levels of goods and services lying below the supply levels of money in the country. As the inflation is caused through an increase in demand, it is called the 'demand pull inflation'. Higher volumes of money supply are generally pumped into the economy of a country when its Government prints more currency or indulges in heavy borrowings to meet budget deficits (Theories, Demand pull inflation). On the other hand, the non-monetarists, also known as the Keynesians, argue that when the Gross Domestic Product (GDP) of a country increases it does so with higher prices sending a message that the economy has passed the stages of full employment levels of output. This type of situation naturally raises the prices of various commodities. In the phenomenon of a cost push inflation, the cost of factors of production increases paving the way for higher prices of commodities. That leads to wage increase and in turn enhances the prices again. When the wage increase is above the levels of the increase in productivity, it naturally leads to inflation. In practice, the factors of prices and wages react to each other as an action-reaction process in a cycle of inflation. Sometimes, famine and other natural calamities would also contribute as factors of inflation. This theory is also supported by the non-monetarists. National currency depreciation, increase in interest rates, imposition of new taxes and removal of subsidies are some of the economic measures that would push up the cost of factors of production and in turn the prices of commodities. 4 The first two measures would lead to certain increase in the costs of raw materials imported, interests rates of borrowings and in turn the cost of factors of production ultimately pushing up the prices. Removal of subsidies and imposition of new taxes would directly affect the consumers at times and indirectly at times (Theories, The non monetarist view of inflation & cost push inflation). Removal of subsidies leads to direct price increase and sometimes the increase can be in hefty volumes. Imposition of taxes will add to the price of the products. If the existing tax rates are increased on raw materials, it will automatically add to the increase in prices. As we are now aware of the different circumstances that generally cause inflation, we have to find out whether or not such a scenario exists in the economy of Greece. For this, as assessment of the several economic measures and factors governing its economy should be considered and studied including its nature of economy. Part B Greek Economy The factors of inflation are always influenced by the Governmental economic policies and the way the monetary system of a country is handled by its central bank and economists. Most of these policies are revealed in the annual budgets and the subsequent programs are implemented in relation to the budget policies only. Greece is no exception to these practices but the prospect of its economy is mainly linked to the fortunes of Euro as it became the sole currency for daily transactions and other economic affairs within the member countries including Greece from January 1, 2002 (Greece currency). Though, as an independent nation, Greece controls its monetary system and economic policies, the growth or downhill of its economy is linked to the 5 governing principles of Euro. The reasons for this are very clear. Greece, being a small economy, depends mostly on tourism and imports for economic survival. Located in Southern Europe, Greece is the world's most popular tourist destination and stands as the 15th among all countries in terms of the number of visiting tourists. In 2001 alone, the country had seen the arrival of 14.7 million tourists bringing along direct revenues of US $ 6.3 billion equaling to 4.9% of the country's GDP. It is most gratifying to note that the number of tourists visiting Greece has been gradually increasing crossing its population figures that stood at 11million. Its magnifying and enchanting tourist destinations received 10588489, 11363822, 12605928, 13567453 and 14646735 tourists in 1997, 1998, 1999, 2000 and 2001 years respectively boosting up the country's tourist revenue considerably (Greece, HRI food service sector / annual report 2004, tourism). In fact, statistics indicate that tourism contributes nearly 20% to the county's GDP, both directly and indirectly. The number of people working in the tourism segment is one-sixth of the total work force in the country. The foreign exchange earned through tourism transactions in 2001 was used to cover 48% of the trade deficit in that particular year (Greece in figures, Tourism: a major engine for growth). This indicates that its economy is very much linked to the country's tourism sector. Consisting of 80.9% mainland and 19.1% islands spread over an area of 1, 31,957 square kilometers with a coastline of 15,021Km, Greece has turned out to be an import 6 dependent country with most of the imports arriving from the European Union(EU). In 2003 alone, it imported goods worth $ 40 billion and certainly, this is a big figure for a population of 11millions (Greece, HRI food service sector / annual report 2004, section 1.Market summary). Greek economy - the present status In the ratings of World Economic Forum (WEF), Greece has come down to the rank of 46 in 2005 from its position of 37 in 2004 in the aspect of global competitiveness, a downfall by 9 grades. In a report released on September 28, 2005, the WEF had stated that Greece had earned the lowest ranking beside Italy that stood at 47 in the sphere of global competitiveness. Greece and Italy are the two lowest ranking countries, except Poland, among the EU-25 nations in the competing ability in the international arena. Thanks to the Himalayan budget deficit caused by the prestigious Athens 2004 Olympic Games, the macroeconomic environment has weakened considerably pushing it back to the lower grades in the international platform (The business and investment world of Greece, Global competitiveness Report 2005-2006: Greece today less competitive than 2004). Is there a threat of inflation Ever since 1998, Greek economy has been facing extreme ups and downs in relation to inflation rates because of several factors such as current account imbalances, ever increasing budget deficits, and changes in wage policies. The following table shows that the country has 7 witnessed the highest rate of inflation at 4.8% in 1998 and the least percentage of inflation at 2.6% in 1999 in the last 8 years ( Greece annual inflation rates). Year Inflation Rate (%) 1998 4.8 1999 2.6 2000 3.2 2001 3.4 2002 3.6 2003 3.6 2004 2.9 As per the Bank of Greece assessment, the Greek economy was burdened with an inflation rate of 3.7 % in 2005 with its GDP growth rate being assessed at 3.5%. The assessed growth rate was down by two percentage points when compared to the statistics of 2004. (Bank of Greece presents interim monetary policy report). The above table shows that the inflation rate was only 2.9 % in 2004 but it rose to 3.7 % in 2005 thanks to the aftereffects of the Olympic Games. The cost of the Olympic Games conducted in 2004 with an expenditure of 7 billion euros (equaling 4.8 billion) has shown its impact on the nation's economy in the following year. Because of the Olympics, the budget deficit in 2004 reached to 5.3% of GDP, above the EU standard level of 3%.( BBC news, Greece vows to cut budget deficit). 8 Inflation to be under control Though the Bank of Greece has assessed the growth rate to be 3.5% in 2005, the 2006 annual budget shows that the actual growth rate was 3.6 in that year. In 2006, the Government aims at reducing the unemployment rate to 9.8% and slowing down the increase in labor cost by one percentage point. The growth rate is expected to be at 3.8% in 2006 showing an increase of two percentage points above the growth rate of 2005. The Government of Greece hopes that the combination of all these factors is expected to send down the inflation rate to 3.2% in the present year with the budget deficit being expected to bring down to 2.6 of the GDP ( Government budget report 2006, prospects for 2006). Going by the 2006 budget indications, there are strong reasons to believe that the economic plans of the Government to keep the inflation rate downwards this year will bear fruit. As the budget indicates, privatization is accorded top priority aiming at growth and employment in the latest budget. Reduction of corporate income tax, expected growth rate of 3.8% as against 3.6 % in 2005, expected increase in total investment volume by 5.4 % and expected rise in exports and services by 6.8 % as against the expected rise in imports by 4.9% are likely to work in favor of the efforts to reduce the inflation rate (Government budget report 2006, prospects for 2006). The import bill will no doubt go up but the exports too will see a growth at a much higher rate than the imports reducing the hike in current account deficit considerably. 9 The above situation will help keep the inflation in control provided there is no big increase in wages and crude oil prices. This atmosphere should also be strengthened by the consolidation of the euro against the major currencies such the American dollar and the British pound. There should not be further devaluation of the Euro. As already pointed out, the inflation rate in 2005 was assessed to be around 3.7%. And the Government plans to bring it to 3.2% in 2006 reducing it by 5 percentage points. In 2004, the inflation rate was only 2.9% as can be seen from the above table. But it went up sharply to 3.7% in 2005. The main reason for the increase in inflation rate was the increase in wage expenditure. The 2005 budget statistics show us that the expenditure on Government wages and pensions in 2005 went up by 5.9%. It was due to increase in wages by a higher rate than the expected inflation rate and also due to increase in pensions by a higher rate than the increase in wages (Government budget report 2005, Wages and pensions). While discussing the theories on the causes of inflation, we found out that increase in wages, above the levels of productivity, contributes to inflation. Particularly in 2005, wage increase was affected above the levels of estimated rates of inflation, boosting up the prices again as a chain reaction. This is one of the reasons for the higher levels of inflation in 2005. The other reasons are the increase in crude oil prices and the depreciation of the Euro. The Euro was depreciated in 2005 by 5.5 % in nominal effective terms and it had a direct effect on the cost of imports. We have already discussed that depreciation of a national currency would raise the cost of imports sending up the cost of the imported raw materials. The reason is that the Government has to pay more money towards the cost of the imported goods and services as the value of the currency goes down. As Greece is imports-dependent, the prices of almost all imported goods 10 have gone up in 2005 casting their effect on the consumer prices (Press releases, Para 4). The increase in oil prices had also cast its spell on prices of essential commodities. Between August and November 2005, the crude prices, no doubt, fell by 5 to reach 47 per barrel but the price was still higher than the average prices of crude in 2003 and 2004 that stood at 25 and 31 per barrel respectively. As a direct result, the transportation of essential commodities became dearer contributing heavily to the inflation (Press releases, Para 4). Again, there were no favorable factors to offset these inflationary trends in 2005 but the 2006 budget proposes some strong balancing factors as we have discussed above. These steps will go a long way to minimize the inflation rate in the coming days. Moreover, Appendix A shows that Greece was burdened every year in the past with ever increasing trade deficit sending the inflation rates up. But this year, the Government hopes to reduce the increase in trade deficit by achieving a higher rate in the increase of exports than the increase in imports. Conclusion The greatest thing about the Greek economy is that most of the times the results are on the expected lines of the programs implemented. But, the Government must commit by the budgetary promises and implement the economic policies in letter and spirit to achieve the targeted level of inflation. The Government must also take steps to see that any wage increase should not be above the levels of expected inflation rates, as happened in 2005. The Government 11 should also continue with the present bank rates as other wise it is likely to send the cost of borrowing upward. It will lead to an increase in the capital and working capital costs. If that happens, the estimates of the Government will turn topsy-turvy and keep the inflation levels up always. But, a strict adherence to the budgetary policy will keep the inflation levels down compared to the inflation rates of last eight or nine years. Appendix A (Economic data of Greece at a glance) GDP Real Unemplo- Inflation Per Exports Imports US $ growth yment Rate (%) Capita (US $) US $ US $ Billion rate (%) rate (%) Billion Billion 1999 149.2 3 9.9 2.6 13,900 12.4 * 27.7* 2000 181.9 3.8 11.3 3.1 17,200 15.8 33.9 2002 201.1 3.5 10.3 3.6 19,000 12.6 31.4 2003 213.6 4.7 9.4 3.6 20,000 5.899 33.27 2004 226.4 3.7 10 2.9 21,300 15.5 54.28 * (indicates figures for 1998) Data for 2001 is not available (Source for Appendix: This is prepared from the electronic ready- to- make data system available at: http://www.indexmundi.com/g/g.aspxc=gr&v=71) 12 Works cited : Books Micco, Alejandro, Ernesto Stein and Guillermo Ordonez. "The currency union effect on trade: early evidence from EMU." EMU: Assessing the impact of the Euro. Ed. Baldwin, Oxford and Malden: Blackwell Publishing, 2003. 23-64. Greece in the European Union. London: Routledge, 2004 Online Dailies Athens News Agency. "Greece facing EU sanctions over budget deficit." Southeast European Times 19 Jan. 2005. URL: http://www.setimes.com/cocoon/setimes/xhtml/en_GB/features/setimes/features/2005/01/19/feature-01 Websites Bank of Greece presents interim monetary policy report, 26 Feb.2006. BBC news, 27 Feb.2006 http://news.bbc.co.uk/1/hi/business/3986395.stm Government budget report 2005, " The 2005 central Government budget," 27 Feb.2006 Government budget report 2006, 27 Feb.2006. Greece, "GAIN report number: GR4008", 26 Feb.2006. Greece annual inflation rates. 28 Feb.2006. http://www.worldwide-tax.com/greece/gre_inflation.asp 13 Greece in figures, 26 Feb.2006. Greece currency, 26 Feb.2006. Press releases, 28 Feb.2006 Theories, 26 Feb.2006. The business and investment world of Greece, "Greece in Figures", 27 Feb.2006. Read More