ECB Researchers Say Inflation Isn’t So Puzzling After All
ECB Researchers Say Inflation Isn’t So Puzzling After All
(Bloomberg) --
Inflation in the euro area might not be as complex as former policy makers such as President Mario Draghi and Executive Board member Benoit Coeure have indicated, according to researchers at the European Central Bank.
Draghi and Coeure, who left late last year after eight-year terms that were dominated by the struggle to restore price stability, both said while in office that structural changes in the economy such as digitalization, globalization, and the expansion of the service sector are complicating inflation. Yet a paper published on Tuesday said traditional models still hold.
“Researchers have suggested many possible factors” for supposedly “missing” inflation and disinflation since the global financial crisis, according to the paper’s authors, Laurence Ball and Sandeep Mazumder, citing speeches by the former policy makers and work by ECB economists. “European inflation behavior is not as puzzling or complex as recent discussions suggest.”
In traditional models, inflation accelerates or slows depending on the level of slack in the economy. A key metric is unemployment, which depresses wages and consequently the ability of households to pay higher prices. That relationship is known as the Phillips curve after the New Zealand economist William Phillips who described it in the 1950s.
That model, which has guided monetary policy for decades, has been widely questioned as policy makers across advanced economies struggle with subdued prices and wages even amid tight labor markets. In response, central banks have plunged into unconventional strategies such as quantitative easing and negative interest rates.
Phillips Curve
In the paper, which doesn’t necessarily reflect the ECB’s official view, the researchers examined “core” price growth that strips out the effects of volatile components. Instead of using the euro zone’s standard indicator which excludes food and energy prices though, they analyzed the weighted median of all industries’ inflation rates, arguing that it produces a less-volatile gauge.
Under that measure, “a simple Phillips curve captures most of the movements in inflation over the 20 years that the euro has existed,” they concluded.
While the paper was published by the ECB, Ball is an economist at Johns Hopkins University and Mazumder is at Wake Forest University, both in the U.S.
The research could be an important contribution to the central bank’s upcoming strategy review under the direction of its new president, Christine Lagarde. The wide-ranging assessment, the first since 2003, will address such weighty questions as whether the inflation goal needs to be changed.
The researchers have a caveat though. Their data runs up to 2018 and in the final two years of that series their equation over-estimated the level of median inflation.
That “suggests there is some truth in the common perception of a ‘missing inflation,’” they said. “We will see whether this anomaly persists, and we should seek to explain it.”
To contact the reporter on this story: Carolynn Look in Frankfurt at clook4@bloomberg.net
To contact the editor responsible for this story: Paul Gordon at pgordon6@bloomberg.net
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