If international organizations and economists are correct, the conservative Greek government is likely to face a combination of a noticeable slowdown in economic growth, a rise in inflation and a larger than anticipated fiscal deficit for the first time since elected to power in March 2004. This constitutes a major challenge for the authorities and may require tough policy decisions. By all accounts, the credit crisis has spread to international stock markets and has started eating into the global gross domestic product growth rate. So, it is no surprise that economists are busy revising downward their forecasts for economic growth as brokerage analysts do with company profits. Greece, although an oasis of growth in the eurozone, could not escape unscathed given the severity of the crisis and the inflationary shock coming from record high oil prices. The latter adds a new element to the economic equation, undermining a key assumption which links global GDP growth with international demand for oil. As the global economy slows, demand for oil is supposed to recede too, driving oil prices to lower levels. However, this has not been the case so far, as world oil prices have broken one historical record after the other to reach the all-time high of $120 a barrel. So, it is to be expected that downward revisions of GDP growth for the Greek and other European Union economies have recently been the norm. The latest forecasts by the European Commission demonstrate this. The Greek economy is projected to slow to 3.4 percent this year compared to 4 percent in 2007. The Commission had forecast a 3.8 percent growth rate for Greece in its previous forecasts published in November 2007. Despite the downward revision, it remains one of the highest in EU-27. In addition, the Commission upped its estimate for inflation broadly in line with the forecasts of local banks and the Greek central bank, putting the average inflation rate at 3.7 percent in 2008 and leaving open the possibility that last year’s budget deficit may exceed 3 percent of GDP. This is a far cry from the GDP growth rates of 5 percent or higher, convergence to average EU inflation and attainment of fiscal balance envisaged by the conservatives when they came to power four years ago. Long gone too are the promises of huge savings from the rationalization and streamlining of the public sector and the overhaul of the civil service. Although some steps were taken in this direction, the desire to avoid a head-on collision with strong interests in the broader public sector, such as trade unions, took precedence. Even the increase in tax revenues came both from strong GDP growth and rises in indirect taxes and levies. Demand It is known that Greece today relies – as it did in the past – on strong domestic demand to boost its economy, since the external sector is a drag. With economic conditions worsening globally, the local economy cannot expect greater assistance from some sectors which have traditionally helped to partly offset the country’s thirst for imports. Exports of goods are not expected to go up as much as in the last few years and foreign tourists are not likely to spend more euros or dollars or other currencies in Greece when they face a slowdown or even recession. Furthermore, the shipping industry’s contribution to growth is not expected to be as strong with freight charges falling. Once again, it will be domestic consumption and investment spending which are going to take up the slack. However, it will be more difficult than before since this time consumers will have to bear the higher oil prices and likely flat economic activity in a sector which has served as one of the engines of growth since early in this decade, namely construction. With little help from the European Central Bank so far and local banks becoming more cautious in lending out and pricing their consumer and mortgage loans, home prices remaining stable or even easing, Greek households can only look forward to higher wages to buy more goods and services. Although higher wages in excess of productivity gains help keep consumption buoyant in the near term, they place a burden on inflation. The latter is one of the highest in the EU, standing at 4.4 percent year-on-year in March, and a major contributor to the gradual erosion of international competitiveness of the Greek economy. So, the global credit crisis is bringing to the surface an issue which is known both to the Greek government and the so-called social partners-workers, employers etc. Strong gross domestic product growth in the short run relies heavily on higher pay which in turn undermines the growth prospects in the medium to long run. The easy way out would have been for all interested parties, that is, the Greek government, trade unions and employers’ associations, to reach an agreement and put a stop to this self-destructive process. However, many would find it difficult to believe such a development could be possible in a country where political cost, personal benefits and ambitions prevail. So, the ball falls in the court of the government, which has two choices to reverse the trend. First, give a strong message to companies and others by opting for a stricter incomes policy in the public sector to help reduce inflation even if it means slower growth in the shortrun. Second, just try to moderate pay increases in the public sector but quickly undertake more sweeping structural changes in the Greek economy. With no help from other factors, such as EU convergence, which helped prop the Greek economy in the last 10 years or even longer, the government has its hands full as it tries to cope with slower growth, higher inflation and the threat of a larger than initially projected budget deficit this year. Following the usual policies is a recipe for stagflation in the future and the global crisis ought to make it more visible to all of us.