HELLENIC REPUBLIC MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy Directorate for Macroeconomic Analysis and Forecasting Directorate General for Economic Policy Directorate for Macroeconomic Analysis and Forecasting

MINISTRY OF ECONOMY AND FINANCE Directorate 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 3 Private Consumption Deflator Inflation in New EU Members (2)

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 4 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 in New EU Members (3)

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 5 Inflation in New EU Members (4) 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 6 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 targets for the government balance and deficit, the inflation rate and the interest rate

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 7 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.

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 8 The Greek Performance in the 1980s The main feature of the Greek economy in the period 1981–1992 was stagflation

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 9 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.

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 10 Greek Convergence Process (1 st 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.

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 11 Greek Convergence Process (1 st 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 12 Greek Convergence Process (2 nd 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%.

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 13 Greek Convergence Process (2 nd 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 14 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 15 Greek Convergence Process (3 rd 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.

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 16 Greek Convergence Process (3 rd period) Short-Term Interest Rates (3 months money market)

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 17 Greek Convergence Process (3 rd period) Bilateral Exchange Rate (GRD/EURO)

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 18 Greek Convergence Process (3 rd period) 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 19 Greece on the Threshold of EMU January 1, 2001 – Greece became the 12 th member of the euro area

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 20 Greece on the Threshold of EMU Long-Term Interest Rates (10-year Government bond yield)

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 21 Greek Convergence Process (3 rd period) 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 22 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.

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 23 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

MINISTRY OF ECONOMY AND FINANCE Directorate General for Economic Policy 24 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

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