hellenic republic ministry of economy and finance directorate general for economic policy...

HELLENIC REPUBLICMINISTRY OF ECONOMY AND FINANCE

HELLENIC REPUBLICMINISTRY OF ECONOMY AND FINANCE

Directorate General for Economic PolicyDirectorate for Macroeconomic Analysis and Forecasting

Directorate General for Economic PolicyDirectorate for Macroeconomic Analysis and Forecasting

MINISTRY OF ECONOMY AND FINANCEDirectorate General for Economic Policy 2

Inflation in New EU Members (1)

• Remarkable progress has been made in bringing inflation down to single-digit rates

• Reducing inflation from relatively low levels to even lower ones is a difficult task

• Inflationary pressure from high productivity growth (the Balassa-Samuelson effect) is cited as the main reason for higher inflation


-10

0

10

20

30

40

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Czech Republic Estonia Hungary Latvia Lithuania Poland Slovak ia Slovenia

Private Consumption Deflator



However, the Balassa-Samuelson effect• cannot explain alone the persistence of

inflation differentials vis-à-vis the euro area;

• is estimated within a range of 1 to 2 percentage points;

• should not be overstated when explaining inflation rates in the new members.




• Inflation criterion is not to be seen as an immediate requirement, but as a medium-term objective

• Progress in nominal and real convergence should be pursued in parallel

• The key element of a successful strategy is to control the sources of inflation, other than the Balassa-Samuelson effect

• balanced monetary and fiscal policy mix

• control of real wage increases


The Convergence Strategy (1)

An essential element of the strategy was its

comprehensive character:• consisted in macroeconomic, monetary and

financial policies – structural reforms and adjustment measures

• with central exchange rate stability criterion, component of an approach incorporating targetsfor the government balance and deficit, the inflation rate and the interest rate


The Convergence Strategy (2)

Taking into account• the inadequate policy mixture of the late

1980s;• the quality of the convergence criteria;• the availability and adaptability of policy

instruments;• the necessary consensus in the Greek

society;• the time horizon.

Greece set the tactical and strategic priorities – disinflation policy was the key element for the nominal convergence effort.


CPI

GDP growth rate

0

5

10

15

20

25

30

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

-4%

-2%

0%

2%

4%

6%

8%

10%

The Greek Performance in the 1980s

The main feature of the Greek economy in the period 1981–1992 was stagflation


The Greek Performance in Early 1990s

By early 1990s, macroeconomic imbalances were among the largest in all industrial countries. In 1991,

• inflation averaged 20%; • fiscal deficit to GDP ratio reached 16%;• current account deficit to GDP exceeded

8%; • real interest rates approached zero.


Greek Convergence Process (1st period)

In response to the macroeconomic imbalances and high inflation• income policy was tightened,• wage indexation system was abolished,• monetary expansion was restrained

along with the• appreciation of the real exchange rate and• weak economic growth

inflation was reduced to low two digit rates by 1994.


Greek Convergence Process (1st period)

• Inflation’s inertia was obstructing any further progress by 1994

• Further tightening of monetary policy in 1994 was the precursor of reorientation of monetary and economic policy


Greek Convergence Process (2nd period)

• In 1995, the Bank of Greece announced as the main and central objective of the monetary policy the deceleration of the inflation.

• HARD DRACHMA POLICY was adopted and a specific exchange rate target was set.

The course of action consisted in two intermediate targets:

• annual depreciation of drachma against ECU (3% in 1995; 1% in 1996);

• containing monetary expansion (the growth rate of M3) to 7%–9%.


CPI

GDP growth rate

0

2

4

6

8

10

12

14

16

1993 1994 1995 1996 1997

-4%

-2%

0%

2%

4%

6%

8%

10%

Greek Convergence Process (2nd period)

• Inflation reached almost 5.5% in 1997, instead of 8.9% in 1995

• Real GDP growth averaged 2.8% during 1995–1997, instead of only 1% during 1992–1994


Disinflation Strategy Success

• The most significant parameters of the hard drachma policy implementation were psychological

• Other initiatives of Greek authorities were facilitated by the low inflation expectations and strengthened the inflation downward momentum:• measures for fiscal adjustment were activated,

so as to reduce the fiscal deficit, relative to GDP• financial system had been almost fully

deregulated• Bank of Greece became fully independent


Greek Convergence Process (3rd period)

The third period of the disinflation process was largely different compared to the 1995–1997 period in terms of tactical movements by Greek authorities • Hard drachma policy was abandoned• GRD joined the ERM, devaluated by 12.3% against

the ECU • The ERM strengthened credibility.

Further reduction in inflation rates was supported by fiscal and structural measures as well as the tactics of a temporary character.



GR

EURO AREA

0.0

5.0

10.0

15.0

20.0

25.0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Short-Term Interest Rates (3 months money market)



150.0

200.0

250.0

300.0

350.0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Bilateral Exchange Rate (GRD/EURO)



Apart from the strict and credible monetary strategy,

• cuts in indirect taxes• public enterprises (utilities, transport) frozen prices • gentleman’s agreements with commercial and

industrial enterprises as well as service providers• adjustments in fiscal policy, so as to achieve lower

deficit ratios• strong productivity growth • moderate wage increases


Greece, CPI

0

5

10

15

20

25

30

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Greece on the Threshold of EMU

January 1, 2001 – Greece became the 12th member of the euro area


Greece on the Threshold of EMU

GREECE

EURO AREA

0

5

10

15

20

25

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

GREECE EURO AREA

Long-Term Interest Rates (10-year Government bond yield)



Apart from the strict and credible monetary strategy,

• cuts in indirect taxes• public enterprises (utilities, transportation) frozen

prices • gentleman’s agreements with commercial and

industrial enterprises as well as service providers• adjustments in fiscal policy, so as to achieve lower

deficit ratios• strong productivity growth • moderate wage increases


Remarks on Greek Convergence Process

Useful lessons drawn from Greece’s successful strategy: • the right setting of priorities; • safety margin maintained, when reducing interest

rates;• strengthening of financial system through the

necessary reforms; • GRD’s time point of entry into the ERM, once

significant progress had already been made;• political consensus for the EMU objective.


• Inflation has converged to the levels close to the EU average

• Nominal and real interest rates have been reduced to the EU average level

• The growth rate of GDP exceeds the EU average

• Unemployment persists (more than 10%)

• Prices are high • Exports are sluggish • Current account deficit remains high

The Greek Post – Euro Era


The goal of entry into the euro area is an ambitious one - it is necessary to start preparing for this prospect well in advance by:

– activating policies for the nominal criteria and structural reforms required for the real convergence in parallel and,

– implementing macro and microeconomic adjustments necessary to join the euro area and maintain the growth momentum.

Most of the new countries have already proceeded with significant steps towards a succesful convergence.

Concluding remarks

Thank you

for your attention

hellenic republic ministry of economy and finance directorate general for economic policy...

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