Inflation is heating up in Europe.

Basic economic theory tells us that loose monetary policy leads to inflation.

In the aftermath of the global financial crisis, central banks around the world cut interest rates to unprecedented levels in a concerted effort to stabilized the global financial system.  Inflation did not immediately follow because of the severity of the economic recession. However, as some economists correctly predicted, it was only a matter of time.

Inflation first reared its head in high-flying emerging market economies like India and China. Now, it has come to Europe. The US is also showing incipient signs of inflation and may soon be hit with this problem.

Below are the European countries that have the highest inflation, as of December 2010. Those marked with an asterisk (*) use the euro currency, which still carries a historically low interest rate. For these euro zone countries with high inflation, the optimal interest rate is probably higher than the European Central Bank’s 1 percent.

Romania              7.9 percent

Estonia                5.4 percent

Greece*              5.2 percent

Hungary              4.6 percent

Bulgaria              4.4 percent

Malta *                4.0 percent

Lithuania             3.6 percent

Belgium               3.4 percent

Luxembourg*      3.1 percent

Poland                2.9 percent

The euro zone, as a whole, has inflation of 2.2 percent.  The European Union is at 2.6 percent. The main drivers of inflation in the euro zone are:

1) Transportation at 5.3 percent

2) Housing, electricity, gas and other fuels at 3.8 percent

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