Thursday, 17 June 2010

Hello Stagflation

The Hellenic Statistics Authority (ELSTAT) released quarterly and 5-month economic statistics yesterday which make for grim reading:

· Inflation (CPI) in May 2010 is up 5.4% year-on-year

· GDP fell by 2.5% in QI 2010 (temporary figures)

· Unemployment rose to 11.7% in QI 2010

· Industrial production fell in April 2010 by 5.1% over April 2009

· Construction fell by 35% in March 2010 over March 2009.

These figures are worse than expected, and can be forecast to continue into the future.

The CPI increase is due mainly to the VAT rise as well as excise taxes on fuel, cigarettes and other items. Only about 1% is estimated to by underlying CPI. With the price of oil predicted to top $ 80/bbl this summer, and future tax rises in the works, we can only assume that inflation will continue to rise, despite the dismal economic situation.

The increasingly present danger is that Greece enters a period of stagflation for the next 2-3 years. A combination of economic stagnation (GDP contraction) and high inflation, this is potentially the worse outcome for a government struggling to implement its Stability and Growth Agreement. It means that basic consumer products become more expensive at the very time when economic activity is less, and unemployment increases.

Figure 1 shows monthly CPI and unemployment figures in Greece from January 2004 – March 2010, sourced from ELSTAT. It’s interesting to note that the period January 2004 – July 2008 appear to be a classic “Phillips Curve”, or an inverse relationship between unemployment and inflation. (The original Phillips Curve was the relationship between wage growth and unemployment). Right in July 2008, however, at the height of Greece’ tourist season, things start to fall apart: unemployment gives a mysterious jump upwards, while inflation peaks and starts to fall.

It’s interesting to note that at roughly the same time, the price of oil collapsed from about $ 140/bbl in July 2008 to below $ 40/bbl in January 2009. Figure 2 shows Greek unemployment and CPI, with an added plot of WTI crude prices in $/bbl on the right axis.

That was also the point where Greek GDP started to fall precipitously. In September 2008, Lehman Brothers collapsed and the credit crisis began in earnest. Figure 3 plots GDP (annual change, current prices) with unemployment and CPI. The GDP figures are temporary and subject to revision.

Looking to the future: most economic analysts indicate a GDP decline of between 2-4% in 2010, followed by a further decline in 2011 and possibly 2012. Assuming a continuing inflation rate due to taxes, oil prices and other factors (such as food prices), it’s clear we are in for a very difficult 2-3 years.

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