Greece’s higher rate of inflation mostly benign, NBG economists claim

The fact that Greece has an inflation rate steadily higher than the eurozone average may not be as worrying as commonly thought. At least this is what National Bank of Greece economists claim in the latest Economic & Market Analysis bulletin (April/May 2003), published in English. Greece’s inflation since it joined the eurozone on January 1, 2001, has consistently outpaced the eurozone average by 1.5 percentage points. However, National Bank economists Nicholas Magginas and Ekaterini Panopoulou say that the observed difference in inflation can be mostly attributed to factors involving Greece’s real convergence or conjunctural factors. As a result, the difference in inflation is mostly «benign» and does not threaten the Greek economy’s competitiveness in the long term. Specifically, the economists see three main factors that explain the inflation differential: higher productivity increases in tradables (that is, those economic sectors open to international competition), which reflect the real convergence of the Greek economy to those of its eurozone partners; the effect of historically low interest rates on total demand; and the effect from the rise in international oil prices. Concerning the first factor, National Bank’s economists consider it natural for a country on a course of real convergence to show higher inflation, since productivity and incomes rise. Moreover, while productivity rises higher in the tradables than in the non-tradables sectors, wages rise at the same rate throughout the economy. Specifically, over the past three years, productivity in tradables – the sectors open to international competition – has been rising 4.5 percent annually, while in non-tradables, the average annual rise has been 3 percent. Wages, on average, have risen 3 percent, that is, below the productivity rise in tradables, according to Bank of Greece data, which the authors tend to dispute. They believe that wage rises have been closer to the rise in tradables productivity. Should this be true, this wage rise explains about half of the differential in inflation between Greece and the EU, or 0.70 percent. Another 0.45 percent in the inflation differential can be explained by the decline in interest rates by 10.5 percent since early 2000. This has provided a boost to economic growth of about 2 percent. Another 0.35 percent is explained by the effect of the rise in oil prices. The authors conclude by warning that almost half of Greece’s higher inflation is still due to «non-benign» factors which could affect competitiveness. The remedy is for the government to produce productivity enhancing structural reforms.