Euro Area Inflation and a New Measure of Core Inflation
University of Milan Bicocca Department of Economics, Management and Statistics Working Paper No. 505
70 Pages Posted: 5 Dec 2022 Last revised: 21 Feb 2023
Date Written: December 4, 2022
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, bears the interpretation of 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 on a downward trend, 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 be lurking ahead. A pressing issue for ECB monetary policy will be to face -mostly supply-side- inflationary pressure without triggering a financial crisis.
Keywords: headline inflation, core inflation, Russia's war in Ukraine, COVID-19 pandemic, sovereign debt crisis, subprime financial crisis, dot-com bubble, euro area, ECB monetary policy, trend-cycle decomposition
JEL Classification: C22, C38, E32, F44, G01
Suggested Citation: Suggested Citation