ECB | Inflation Diagnostics

Blog post by Philip R. Lane, Member of the Executive Board of the ECB |

Identifying the medium-term inflation path in the current environment of high inflation, ongoing energy and pandemic-related shocks and the Russian invasion of Ukraine is a diagnostic challenge. In his ECB Blog post Philip R. Lane, Member of the ECB’s Executive Board, describes some of the key analytical issues involved.

Summary

This blog post describes the diagnostic challenges in identifying the medium-term inflation path in the current environment of high inflation, ongoing energy and pandemic-related shocks and the Russian invasion of Ukraine.^[1] It interprets the surge in inflation since the middle of 2021 as the result of extraordinary relative price shocks that, in the presence of downward nominal price and wage rigidities, initially translate into an increase in the inflation rate. These relative price shocks reflect the scale and breadth of the energy shock and the pandemic- and war-related shocks. Under such circumstances, standard measures of contemporaneous underlying inflation may not accurately signal the persistent component of inflation, while forward-looking wage growth trackers may play a useful supplementary role in identifying the medium-term inflation dynamics. Long-term inflation expectations currently appear well anchored at the two per cent target, but a prolonged phase of above-target inflation poses a de-anchoring risk that is addressed by raising interest rates to the levels required to make sure that inflation returns to target in a timely manner.

Read the full blog post here.

Compliments of the European Central Bank.