Greece Internal Devaluation Update

April 23, 2013, 2:48 PM ET

ByMatthew Dalton

The Wall Street Journal

            Without the tool of currency devaluation, the euro zone is hoping “internal devaluation” can restore competitiveness to the bloc’s periphery. What’s that?

It’s an economy-wide fall in wages and, more broadly, prices. Officials have been careful not to say the “D” word – that’s “deflation” – but Europe’s policies call for a period of deflation in euro-zone countries with the worst competitiveness problems.

The prime example is Greece. As the International Monetary Fund said in its last report on Greece:

Large external liabilities ultimately require large trade surpluses in order to service them, and achieving these surpluses requires a more depreciated level of the real exchange rate. In a currency union the depreciation has to be achieved largely through deflation, which necessitates a larger negative output gap.

So, how has the deflationary process been playing out in Greece? Not too well. There has been a sharp drop in Greece’s nominal gross domestic product (that’s the one that doesn’t adjust for inflation), which the IMF now projects will have fallen more than 20% by the end of this year since 2008.

Yet annual consumer-price inflation has remained positive for most of Greece’s battle with the crisis (yes, this partly due to tax increases adopted as part of Greece’s austerity program, but still…)

Then look at Greece’s sharply falling labor costs: appr. 90% of the 2008 cost.

This portrays an economy in which ordinary people have seen their purchasing power crushed by a combination of still rising prices and falling wages. Businesses haven’t been passing through lower labor costs into the prices they charge consumers and other businesses.

The IMF and euro-zone authorities have blamed Greece’s inflation on still-powerful oligopolies in the Greek economy that don’t feel competitive pressure to cut their prices. That’s why overhauls intended to break up these oligopolies are now such a key part of Greece’s bailout program.

The latest inflation data give an indication that some of these measures may be starting pay off. In March, Greek consumer prices actually fell 0.2% from February. Compared with a year earlier, however, inflation was still 1%.

That the first signs of actual deflation may be appearing only now, in the sixth consecutive year of recession, underlines that the road to internal devaluation in Greece likely remains long and hard.

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