What a difference six months can make. At the beginning of the year, the vast majority of Greek high-level bankers and government officials thought the international financial crisis would have a minor impact on local banks and the economy. The same people today appear to be more pessimistic, citing the rise in inflation on the back of a steep hike in global oil prices and the slowdown of the economy. The question is not whether they get it right this time but whether the damage to the economy can be contained. For the first time since the 1970s, the world is facing the prospect of stagflation, that is, the co-existence of high inflation and a growth or outright recession. It should be remembered that a growth recession occurs when an economy grows below its trend for the long-run and outright economic recession when its gross domestic product (GDP) shrinks for three consecutive quarters or longer. The first oil shock in the 1970s found the Greek economy in a transition stage, since it nearly coincided with the return of democracy to its birthplace. The conservative New Democracy government under former Prime Minister Constantine Karamanlis, the uncle of the present prime minister, adopted a Keynesian macroeconomic policy which succeeded in bringing down inflation and kept the economy growing at a satisfactory pace. However, it did not manage to uproot inflation and drastically lower inflationary expectations. So when the second oil shock arrived in the late 1970s, the country was not well-prepared to manage it. The election of the socialist PASOK party under former Prime Minister Andreas Papandreou to power in 1981 brought a more expansionary fiscal and monetary policy, spiced with state interventionism. The price Greece paid for not adjusting on time to the new global landscape was to lag behind its European Union peers for more than a decade. Greek policy makers are well aware of the lesson of the 1970s and do not want it to be repeated. However, although the local economy appears to be in better shape than the period leading up to the two major oil shocks of the 1970s, policy makers are fully aware that the country’s political and social system is not receptive to the necessary economic medicine. Within this context, there is a risk Greece will fail to adjust and lag behind its peers for another multi-year time span if the dynamics of stagflation are not arrested at a global level, something rather difficult before the US elects its new administration. Of course, Greece, like other countries, can hope that international oil prices will come down from their record-setting levels to reduce inflation and allow for lower interest rates along with restoring some of the purchasing power of households and compressing the current account deficit. It should be emphasized that annual inflation reached 4.9 percent in May, a 10-year high, boosted by higher oil and food prices. Moreover, the current account deficit expanded to 11.06 billion euros, an increase of 11.8 percent in the first four months of this year, compared to the same period last year. The majority of the expansion of the current account deficit came from the 1.2 billion euros in the oil balance account. Even if world oil prices recede, Greece, like other eurozone importers, may find out that it will not do them much good because the euro may slide against the dollar. So, in the same way a strong euro has mitigated the negative effects of the steep rise in international oil prices, a weaker currency may do the same on the other side. With inflation running high and the collective wage agreement compensating for more than its increase, the prospects for Greece keeping second-round effects from being passed on in consumer prices do not look promising. Greece is likely to continue to find itself in the group of the eurozone’s high inflation countries. But the global credit crunch, along with high inflation, have brought higher deposit and lending rates. The higher interest rates in time deposit accounts tend to discourage consumption which is the main pillar of aggregate demand. In addition, the higher lending rates have increased the burden of debt-servicing households, contributing to a restriction in consumer spending growth. Of course, on the positive side, employment appears to be doing well and personal disposable incomes are on the rise. Also, real estate and private construction activity, which are both sensitive to interest rates, personal income growth and the sector-specific conditions point to a slowdown. If all is put together, the picture points to a weaker Greek economy in the months ahead. The good news is that the economy looks able to grow by more than 3.0 percent in 2008. This may fall well behind earlier state and private sector expectations but it is much better compared to a subpar 2.0 percent average growth in the 10 trillion eurozone economy.