Accounting for the recent inflation burst in the euro area

Domenico Depalo and Salvatore Lo Bello ()
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Salvatore Lo Bello: Bank of Italy

No 871, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We estimate a semi-structural model of wage and price inflation for the euro area following the framework set down by Bernanke and Blanchard (2023). Adding multiple labour market slack variables improves the fit of the wage equation, consistent with the findings of the recent literature. In contrast to the US, temporary wage shocks do not have permanent effects on price inflation. Temporary price shocks may trigger a self-feeding mechanism that eventually results into persistently higher inflation. Hence, the effect of shocks to labour market slack is smaller than those to the price of intermediate inputs of production. Historical decompositions reveal that the tightening of the labour market can explain only a minor share of wage inflation dynamics between 2020 and 2023, and the surge in price inflation can be entirely accounted for by the combined effect of energy inflation, food inflation and shortages. The subdued effect of labour market shocks on price inflation can be traced back mainly to the weak wage-to-price pass-through, notwithstanding the significant response of wage inflation.

Keywords: wage inflation; price inflation; unemployment; labour market tightness; economic slack; energy shock; shortages (search for similar items in EconPapers)
JEL-codes: E31 J31 J63 J64 (search for similar items in EconPapers)
Date: 2024-10
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