ECONOMY

Inflationary causes and illusions

There is a type of illusion related to money – not wealth, but the «humble» money handled by ordinary people in the street. A recent study by the Organization for Economic Cooperation and Development (OECD) showed that most people would by far prefer a 7 percent raise in wages when inflation may even run higher rather than a 5 percent raise with zero inflation. Of course, the two alternatives may not always be comparable; under inflationary conditions, taxes and negative returns on savings are likely to affect real income more, while it often pays to be in debt contracted at a fixed rate. But the general observation remains valid: Most people feel better with the idea of a nominally higher pay raise. On the other hand, firms are usually very quick to pass on cost increases to the consumer, whereas when costs fall, the adjustment, if it takes place at all, is usually delayed. Indeed, in markets where competition is weak, cost reductions are rarely reflected in lower prices. According to the OECD study, this is a basic reason why inflation remains relatively high in the eurozone. This applies much more to Greece, where inflation remains at much higher levels than the eurozone average and is likely to have serious repercussions if it persists; high inflation eats into a country’s competitive advantages, undermining businesses, employment and income. To date, the government’s stand on the issue is contradictory; officials often claim the problem does not exist while, at the same time, they announce drastic measures against firms putting up prices, including tax inspections. At another level, the government, while unable to reduce budget spending, stokes inflation by allowing public utility rates to rise; and while there is no doubt that a significant part of inflation is produced by the broader public sector, the threats are directed against private enterprises, where they are known to be ineffective. What is really needed is greater competition, which compresses prices; it is no coincidence that rates are only falling in the telecommunications sector where competition is strong. So, to deal with the causes of inflation, speed up the pace of structural changes.