Natural Gas Prices and Unnatural Propagation Effects: The Role of Inflation Expectations in the Euro Area

Abstract

This paper investigates the recent increases in natural gas prices and its propagation effects via inflation expectations. Using a structural vector autoregression, we identify a euro area natural gas price shock with a combination of sign- and zero-restrictions. We rely on market-based measures of inflation expectations. We find that natural gas price shocks have strong effects on both inflation and inflation expectations. To understand the relative importance of the pass-through from inflation expectations to inflation after a natural gas price shock, we conduct a counterfactual analysis in which we turn off the expectation channel. Our findings indicate the presence of strong second-round effects via expectations. Furthermore, these effects are stronger for short-term expectations than for long-term expectations. Our analysis provide a guidance for policymakers to better understand the potential trade-offs of different policy responses to natural gas price shocks.

Keywords: Natural Gas Price Shocks, Inflation Expectations, Euro Area, Counterfactual Analysis

JEL Classification: C32, E31, Q43