Why does the revovery show so little inflation

Christophe Blot (1) , Jérôme Creel (1) , Paul Hubert (1)

1 OFCE - Observatoire français des conjonctures économiques (Sciences Po)

Low inflation despite economic recovery has given rise to the puzzle of “missing inflation”. Yet there would be no puzzle if the recovery is incomplete. While GDP is on the rise, some slack may still be present in some countries of the euro area. Against this backdrop, we investigate the empirical determinants of inflation and we investigate their relative contributions to actual inflation since 2000 to explain why inflation is currently low. Drawing on empirical estimations, we explain the dynamics of inflation since 2000 by different cyclical and structural factors. We also introduce an indicator of both conventional and unconventional monetary policies to assess the direct incidence of ECB's policies on actual inflation. All these factors explain the bulk of inflation variance since 2000. The most important determinants of inflation in the euro area are inflation expectations and wage growth. Both indicators have contributed negatively to inflation since 2014 but inflation expectations less so since 2015 whereas the contribution of wage growth has remained constant. Drawing on evidence of uneven recovery across euro area Member States, it shall be recommended to keep on pursuing the expansionary stance of monetary policy until the ECB achieves its inflation objective. Moreover, the evolution of inflation and its determinants do not meet the conditions that the ECB regarded as genuine progress towards its policy objective. Inflation has not yet happened and is not expected in the medium-run; moreover, without second-round effects on wages, it is not yet possible to expect that once inflation goes back to target, it will be selfsustained. The features of the ongoing developments in wage-price inflation suggest a decrease in the nominal anchor. The recent structural reforms may have put a drag on the ability of the ECB to reach its inflation target rapidly. The timing of structural reforms is important. They may be helpful at fostering innovation and productivity provided they are implemented after economic growth has been sustained and evenly distributed across the Member states, and after inflation has reached its medium-run objective.

Mots clés: European Central Bank; Quantitative Easing; Low inflation; Inflation expectations; Wage dynamics; Output gap

Domaines: Economies et finances

Christophe Blot, Jérôme Creel, Paul Hubert. Why does the revovery show so little inflation. OFCE Policy Brief, 2018, 33, pp.1 - 12. ⟨hal-03471719⟩