Decomposing the Consumption Deflator

Abstract

This letter proposes a novel consumption deflator decomposition which allows linking consumer price inflation directly to import prices, domestic profits, and domestic labor costs. Applying the decomposition to the recent inflation spike in the euro area shows that import prices accounted for 40 percent of the consumption deflator increase over 2022Q1 to 2023Q1, while domestic profits accounted for 45 percent. The subsequent disinflation process saw the unit profit and import price contributions unwind, while in line with historical precedence unit labor costs became the largest contributor. The results imply that firms passed on more than nominal cost shock during the inflation spike, but the available data does not point to widespread changes in profitability.

Keywords: Inflation, wages, Profits, Terms of Trade