The difficulty of wording this question is indicative of Scott Sumner’s point about the poverty of our language. Here is Scott:

The most recent inflation rate in Greece is 1.7%, whereas Spain has 1.9% inflation. I don’t know about you, but I find those figures to be astounding. That’s not deflation, and yet Tyler’s clearly right that they are being buffeted by powerful deflationary forces. 1. This shows the poverty of our language. Economics lacks a term for falling NGDP, even though falling NGDP is arguably the single most important concept in all of macro, indeed the cause of the Great Depression. So we call it “deflation” which is actually an entirely different concept. I wouldn’t be the first to find connections between the poverty of our language and the poverty of our thinking. 2. Through experience I’ve learned that whenever a data point seems way off, there are probably multiple reasons. Thus Greece and Spain probably have less price level flexibility due to structural rigidities in their economies. And the inflation might be partly due to special factors like increased VAT or higher oil prices. Nonetheless, these sorts of depressions would have been associated with falling prices in the 1930s, so it’s not your grandfather’s business cycle.

One option (not the only piece of the puzzle) is that automatic stabilizers, in the form of highly inefficient government jobs and government-privileged jobs, are maintaining consumption, at some level, in the periphery economies. The deflationary pressures are being driven by the collapse of intermediation and are being “taken out” in the form of lower investment and lower capital maintenance. Look for instance at the M3 collapse in Italy.

This would have a few implications. First, the fiscal austerity story becomes more obviously secondary to the deflationary story, though not irrelevant. If the fiscal austerity story were driving the deflationary pressures, you might expect to see lower rates of price inflation, unless you think it all can be pinned on VAT increases (doubtful). Second, it is probably a more pessimistic view, since it implies things only look as good [sic] as they do because in essence current consumption is being funded by eating into capital growth and maintenance.

Third, given high rates of unemployment in Spain and Greece, those economies should not be operating at or near full capacity. High rates of price inflation suggests the importance of bottlenecks, which in turns means this is an AD and also an AS story, and not just a pure AD story.

I would stress the speculative nature of this discussion. In any case this is an extremely important but radically underdiscussed issue. It makes a lot of different theories look bad, and thus makes it harder to maintain an attitude of thundering certainty.