Staff Working Paper No. 1,170
By Clemente Pinilla-Torremocha
This paper investigates the post-Covid inflation surge in the euro area, combining three features: decomposition of long-term trends and business-cycle dynamics – such as potential GDP, trend inflation, output-gap, and inflation-gap; time-varying volatility and fat-tailed distributions to accommodate extreme observations; and structural shock identification, distinguishing shocks by their persistence (permanent versus transitory) and domain (global versus domestic, demand versus supply, or energy specific). Unlike the existing literature, findings show that domestic supply shocks feed into the persistent component of euro-area inflation, raising trend inflation to 3% by 2022. Demand shocks – domestic and global – manifest in the transitory component (inflation gap), explaining 85% of the post-Covid inflation surge.
Persistent and transitory inflation in the euro area: insights from global and domestic shocks
