Euro Area Inflation Research Articles

The Impact of Weight Shifts on Inflation: Evidence for the Euro Area HICP

Shifts in household consumption feed into euro area inflation via the annual updating of product weights. The partial effect of weight changes on inflation is not quantified by statistical offices. We therefore propose a decomposition of the inflation rate, measured by the annual percentage change of the Harmonised Index of Consumer Prices (HICP), into the overall price change assuming weights at the previous year’s level and a weighting effect. We discuss this decomposition against a decomposition into pure price change and quantity effects. Our empirical results show that euro area inflation has been noticeably impacted by weighting effects since 2021. Before 2022, we observe a close relationship between weighting and quantity effects. As weighting effects can be calculated without delay from publicly available HICP data, we argue that this decomposition is relevant in terms of providing timely information for analysts and monetary policymakers.

Euro area inflation in the era of COVID‐19: A permanent or a transitory phenomenon?

AbstractThe goal of this paper is to test the mean reversion process of the inflation rate in the Eurozone during the COVID‐19 pandemic crisis. The study uses weekly data on consumer prices (measured through the Harmonized Consumer Price Index), spanning the period from 2020 to the mid of 2022. The findings document that euro area inflation follows a mean non‐reverting process, with most of its components following a similar pattern. Moreover, sub‐period analysis illustrates that the vaccination process against the pandemic gives a transitory character to euro area inflation, which, however, is dominated by the lockdown and the Omicron mutation periods. Finally, comparative analysis illustrated the differences of inflation persistence during the Global Financial Crisis of 2007–2009.

Gas Price Shocks and Euro Area Inflation

Gas Price Shocks and Euro Area Inflation

Supply or Demand, that is the Question: Decomposing Euro Area Inflation

Supply or Demand, that is the Question: Decomposing Euro Area Inflation

What can keep euro area inflation high?

SUMMARY A central bank that faces inflation above target may fail to bring it down. This article discusses six ways in which this happens because the central bank is dominated by: misjudgement, expectations, fiscal policy, financial markets, recession fears, or external forces. It applies this approach to the challenge facing the ECB in 2023–24. The hope is that the factors identified can serve as warning signs for what to avoid.

Euro area inflation and a new measure of core inflation

This paper introduces a new decomposition of euro area headline inflation into core, cyclical, and residual components. Our new core inflation measure, the structural core inflation rate, is the expected headline inflation, conditional to medium to long-term demand and supply-side developments. It shows smoothness and trending properties, economic content, and forecasting ability for headline inflation and other available core inflation measures routinely used at the ECB for internal or external communication. Hence, it carries additional helpful information for policy-making decisions. Concerning recent developments, all the inflation components contributed to its post-pandemic upsurge. Since mid-2021, core inflation has been downward, landing at about 3% in 2022. Cyclical and residual inflation-associated with idiosyncratic supply chains, energy markets, and geopolitical tensions- are currently the major threats to price stability. While some cyclical stabilization is ongoing, a stagflation scenario cum weakening overall financial conditions might emerge. A pressing issue for ECB monetary policy will be to face -mostly supply-side- inflationary pressure without triggering a financial crisis.

Forecasting euro area inflation using a huge panel of survey expectations

In this paper, we forecast euro area inflation and its main components using a massive number of time series on survey expectations obtained from the European Commission’s Business and Consumer Survey. To make the estimation of such a huge model tractable, we use recent advances in computational statistics to carry out posterior simulation and inference. Our findings suggest that including a wide range of firms’ and consumers’ opinions about future economic developments offers useful information to forecast prices and assess tail risks to inflation. These predictive improvements arise from surveys related to expected inflation and other questions related to the general economic environment. Finally, we find that firms’ expectations about the future seem to have more predictive content than consumer expectations.

The COVID-19 recession on both sides of the Atlantic: A model-based comparison

This paper compares the COVID-19 recession in the euro area (EA) and the US using an estimated multi-region New Keynesian macroeconomic model. To capture quarterly dynamics from 2020 onwards, we introduce relevant extensions such as ‘forced’ savings, extensive versus intensive employment margins, and trade in commodities as inputs to production and final demand. Transitory (‘forced’) savings are central to account for the behaviour of economic activity in both regions during the pandemic, which was strongly driven by private consumption, alongside other shocks to domestic demand and shocks to foreign activity. The model highlights the importance of demand recovery and rising commodity prices for the inflation acceleration during 2021–22. EA inflation has a stronger supply component (including commodity prices) compared to a stronger demand component in the US.

Where is the Euro Area headed? Restoration of price stability

After the two recent global shocks of the COVID-19 Pandemic of 2019–2021 and the Russian invasion of Ukraine in February 2022, the 2023–24 economic priority for the Euro Area is the fight against inflation in the midst of global economic and financial uncertainties. We focus on Euro Area inflation, analyze its diagnostics, examine inflation expectations, review theories of inflation and evaluate monetary and fiscal policies prompted because of COVID-19. Then we explore policies of the European Central Bank to fight inflation and conclude that restoration of price stability in the Euro Area will remain its central focus during 2023 and 2024.

Euro Area Inflation after the Pandemic and Energy Shock: Import Prices, Profits and Wages

Euro Area Inflation after the Pandemic and Energy Shock: Import Prices, Profits and Wages

Nowcasting inflation with Lasso‐regularized vector autoregressions and mixed frequency data

AbstractWe evaluate the predictive performances of the least absolute shrinkage and selection operator (Lasso) as an alternative shrinkage method for high‐dimensional vector autoregressions. The analysis extends the Lasso‐based multiple equations regularization to a mixed/high‐frequency data setting. Very short‐term forecasting (nowcasting) is used to target the Euro area's inflation rate. We show that this approach can outperform more standard nowcasting tools in the literature, producing nowcasts that closely follow actual data movements. The proposed tool can overcome information and policy decision problems related to the substantial publishing delays of macroeconomic aggregates.

Euro Area Inflation and a New Measure of Core Inflation

Euro Area Inflation and a New Measure of Core Inflation

The Asymmetric Effects of Weather Shocks on Euro Area Inflation

The Asymmetric Effects of Weather Shocks on Euro Area Inflation

Euro Area Inflation Differentials: The Role of Fiscal Policies Revisited

Euro Area Inflation Differentials: The Role of Fiscal Policies Revisited

Supply or Demand, that is the Question: Decomposing Euro Area Inflation

This paper studies the recent trends in inflation in the euro area and estimates to what extent the current inflationary pressures are driven by demand expansion and by supply side disruptions. First of all, consumer price inflation is particularly pronounced in goods and less so in the case of services. Energy and food are the most relevant components of rising consumer prices, accounting for almost three-quarters of total headline inflation. The fact that price pressure comes mainly from sectors with a high import content suggests that disruptions along international supply chains may play a key role. The paper then focuses on producer prices at the sectoral level and presents a methodology to decompose the rise in inflation between supply and demand impulses. It finds that, in the present context, supply factors are the main driver and account for at least 80% of the current increase in producer prices in industry and in each one of the manufacturing sectors with the highest price pressures. There are nevertheless some differences across countries. These findings imply that, if repairing supply-side problems and disruptions along supply chains is the priority, then promoting the right investment may be more urgent than cooling demand down. Country heterogeneity in the relative importance of demand and supply factors, then, may lead to different degrees of effectiveness of monetary policy and to a risk of divergences.

The case for a positive euro area inflation target: Evidence from france, germany and italy

Using micro price data underlying the consumer price index, we estimate relative price trends over the product life cycle in France, Germany and Italy. Minimizing the welfare consequences of relative price distortions in the presence of these trends requires targeting a significantly positive inflation rate: the steady-state inflation rate jointly maximizing welfare in all three countries ranges between 1.1%-1.7%. The welfare costs of targeting an inflation rate of zero, as suggested by monetary models ignoring relative price trends, or of targeting 4% amount to several percentage points of consumption.

Evaluating the Effectiveness of Quantitative Easing Measures of the Federal Reserve and the European Central Bank

This scientific paper examined the relation between conventional and unconventional monetary policy, with an anticipation to provide a comprehensive assessment of how they behave with the goal of mitigating financial distress, at the state level, influencing global economy. The sampling frame involved five variables related to the US Federal Reserve and five variables related to the European Central Bank, observed during the period 2015-2020 (data for January, April, July and October of each year, regarding every research variable were collected). These variables included: Euro Area Inflation Rate, ECB Bonds Yields, Euro Area Broad Money Supply (M2), Euro Area Unemployment Rate, Debt to GDP; and US Inflation Rate, US Treasury Yields, US Broad Money Supply (M2), US Unemployment Rate, Debt to GDP. Accordingly, two adequate research models were created. Research methodology focused on examining the accuracy of the hypotheses using SmartPLS 3 as a tool for conducting mediation analysis. Research implications suggest that Quantitative Easing caused a significant increase in the Federal Reserve’s and European Central Bank’s balance sheet, especially during the global financial crisis (2007-2008) and during the post-crisis, recovery period. In terms of policy recommendations, monetary authorities need to have policy sets ready in place, in order to know how to behave during and post an economic crisis. This scientific paper will serve as an accurate source of information to future researchers in the field of conventional and unconventional monetary measures, because the work is well systematically organized, clear for interpretation and provides an extensive insight into the Fed’s and ECB’s transmission mechanisms of monetary policy.

Determinants of Inflation Expectations in the Euro Area

Euro area inflation has been rising strongly in the wake of the COVID-19 pandemic, giving rise to concerns that there could be second-round effects, with higher inflation leading to higher inflation expectations, which in turn lead to higher inflation. This could result in more persistent rises in inflation.

Does the Phillips curve help to forecast euro area inflation?

We find that it does, but choosing the right specification is not trivial. Based on an extensive forecast evaluation we document notable forecast instabilities for most simple Phillips curves. Euro area inflation was particularly hard to forecast in the run-up to the Economic and Monetary Union and after the sovereign debt crisis, when the trends—and, for the latter period, also the amount of slack—were harder to pin down. Yet, some specifications outperform a univariate benchmark and point to the following lessons: (i) the key type of time variation to consider is an inflation trend; (ii) a simple filter-based output gap works well, but after the Great Recession it is outperformed by endogenously estimated slack or by “institutional” estimates; (iii) external variables do not bring forecast gains; (iv) newer-generation Phillips curve models with several time-varying features are a promising avenue for forecasting; and (v) averaging over a wide range of modelling choices helps.

The COVID-19 shock and challenges for inflation modelling

We document the impact of COVID-19 on inflation modelling within a vector autoregression (VAR) model and provide guidance for forecasting euro area inflation during the pandemic. We show that estimated parameters are strongly affected, leading to different and sometimes implausible projections. As a solution, we propose to augment the VAR by allowing the residuals to have a fat-tailed distribution instead of a Gaussian one. This also outperforms with respect to unconditional forecasts. Yet, what brings sizeable forecast gains during the pandemic is adding meaningful off-model information, such as that entailed in the Survey of Professional Forecasters. The fat-tailed VAR loses part, but not all of its relative advantage compared to the Gaussian version when producing conditional inflation forecasts in a real-time setup. It is the joint fat-tailed errors and multi-equation modelling that manage to robustify models against extreme observations; in a single-equation model the same solution is less effective.