Wednesday, 15 June 2016

Greek deflation: just due to import prices falling?

When one looks at Greece’s inflation dynamics, he/she is bound to draw the conclusion that the deflation spell that the country is experiencing is due to the 24% drop in final consumption expenditure. That’s textbook stuff right? Well, textbook stuff rarely apply to Greece’s monstrously distorted economy.

One look at import prices though may prompt people to think differently and start examining other eventualities.

source: ELSTAT
As you can see a couple of months before Greece’s consumer prices index entered deflation territory, import prices index had done so. Moreover, the renewed dive in CPI in late 2014 was again preceded by a dive in import prices.

Someone could think, “ok but we all know that prices display at least some degree of downward rigidity”. In Greece some means prices peaking about four years later than final consumption expenditure did. Final consumption peaked in 2008 while CPI peaked in 2012.

source: Eurostat, own calculations

In Ireland on the other hand, consumer prices peaked on the same year that final consumption did. They did of course start rising again before final consumption rebounded but most likely this was due to indirect taxes being hiked in 2011. 

source: Eurostat, own calculations

One further objection that could be raised is that the hiking of taxes (direct and indirect) that took (and still takes) place these past (not so) few years distorted inflation’s trajectory in Greece’s case as well. 

Luckily, Eurostat publishes a HICP time series under the assumption of constant tax rates. If one bothers to look at it she/he will find out that this indicator peaked in 2012 as well. The difference between the two is that under constant tax rates, consumer prices would have peaked 6-7 months earlier. 

The period until end-2012 bore the brunt of the decrease in final consumption. However, consumer prices not only didn't fall as a response to plummeting demand but continued to rise.

source: Eurostat, own calculations

To wrap this up, the evidence presented above show without any doubt that calling products and services markets in Greece simply distorted is a euphemism. It would not be excessive for one to claim that they barely function at all. If prices had fallen along with demand (at least up to a degree), consumers’ purchasing power would have been less hard hit and the depression would feel (a bit) less severe.