The Chart That Should Prevent An ECB Policy Mistake

This report argues that the ECB is likely overreacting to inflation risks by ignoring evidence of labor market cooling and firm-level price-setting behavior. The author demonstrates that adding supply chain pressure metrics to inflation models provides no predictive value compared to labor and energy cost variables.

Key Takeaways

• 1.The ECB risks overreacting with further rate hikes as labor market weakness and firms' price-setting behavior indicate lower inflation pressure than central bank models suggest.
• 2.Standard 'supply chain pressure' indicators provide no additional explanatory power for Euro Area core inflation when energy prices and labor tightness are already modeled.
• 3.Changes in firms' price-setting behavior (measured by frequency of price changes) represent a critical regime-shift factor that, combined with labor tightness, drives sticky core inflation.

Table of Contents

• The Chart That Should Prevent An ECB Policy Mistake
• At a basic level, energy prices and labour market tightness explain most of EA core inflation.
• What about indicators of “supply chain pressures”? Do they improve the estimates? Not really.
• Appendix

Document Preview

Page 1 of 5

Subscribe for full accessStart Free Trial