Greece Economy & Market Analysis - November 2012

Rapid labor cost adjustment versus consumer price inertia: The asymmetric adjustment puzzle reflects once-off factors as well as structural rigidities

The macroeconomic adjustment achieved during the first two years of the program is notable, but characterized by a high degree of inertia. Despite the delay, employment and wages have now undergone an impressive adjustment.

Wage compression has translated into material declines in nominal ULCs, which NBG Research estimates will cumulatively exceed 12% in the period 2012-13, following an adjustment of 6½% in 2010-11, easily exceeding the 2nd program target for a ULC correction of 15%.

Consumer prices have exhibited even greater inertia due to a combination of factors. Tax hikes and high energy prices appear to have delayed the adjustment of consumer prices significantly. Without their impact, prices would have declined by about 2.8% in 2010-12. Inflation has also been pushed up by imported inflation arising from the still high share of imports linked to consumption (final goods as well as inputs), reflecting a narrow domestic production base (a very high ratio of intermediate and consumer goods imports to manufacturing value added).

However, the disinflation process appears to be gaining momentum in recent quarters, as accelerating wage cost declines are evident in a broad-based disinflation in the business services sector (-2.0% y-o-y in September), which is gradually supporting reductions in the prices of goods. NBG Research empirical evidence finds that prices adjust to wages with a 5 quarter lag, implying that the period of sharp wage declines is only now starting to feed through to prices.

Disinflation appears now being supported by rapidly declining domestic costs (such as transportation, storage, legal and accounting services), which are down 5.6% y-o-y in Q3:2012, as well as shrinking profit margins, especially in the period 2010-11, reflecting domestic firms’ reduced pricing power.

Adding together the estimated contributions of the main structural and conjunctural drivers of inflation, and adjusting for transmission lags, NBG Research estimates that disinflation at a consumer price level will gain momentum in 2013 and especially in 2014 resulting in a return of Greek relative price competitiveness to its 2002 level by end-2014.

 The analysis also includes :

Overview of economic & Fiscal  developments in Greece, including analysis of 2013 Government Budget 

Macroeconomic Outlook and forecasts for 2013