Some Facts about Recent Euro Area Inflation

March 31, 2014

The twelve-month rate of total consumer price inflation fell to 0.5% in March 2014 from 1.7% in March 2013 and 2.7% in March 2012.  It would hit zero as soon as August or September if that pace of decline were sustained in linear fashion.

Disinflation during the past year had broadly based sources.  39.4% of the 1.2 percentage point decline of inflation between March 2013 and March 2014 reflects a reduction of the core components.  Core inflation slowed to 0.8% from 1.5% in the prior twelve months.  Within core inflation, non-energy industrial goods accounted for 15.2% of total inflation’s deceleration over the past year, and consumer prices for services were responsible for 24.2% of the overall deceleration of inflation.  Energy price inflation which swung from 1.7% in the year to March 2013 to negative 2.1% in the ensuing year to March 2014, accounted for exactly a third of the deceleration in overall CPI inflation.  The price increase in food, alcohol and tobacco products was 1.0% in the latest twelve months, down from 2.7% in the previous statement year, and this decline was responsible for 27.3% of the reduction of inflation from 1.7% to 0.5%. 

The European Central Bank is self-mandated to deliver medium-term total CPI inflation that is below, but close to, 2.0%.  To put a fine point on it, that implies roughly 1.7-1.9%.  The ECB has been at this task for the past 15 years.  Over the first nine of them, total consumer prices rose at a 2.3% per annum pace, and core inflation was 1.8% per year.  Nine years constitutes a long run, not to mention a medium span of time, so the central bank in the early years failed on the upside, but the average size of the miss was just 0.4% per year.  Moreover, core inflation was within target, so inflation only exceeded the goal because of rising world energy prices that was caused by supply disruptions in the middle east and strongly growing demand from developing economies.  Over the past six years, total inflation has averaged 1.6% per year, and the core rate was 1.3% per annum.  Both measures are below target, making the miss to the downside more definitive than the earlier miss to the upside.  A second reason why the more recent type of error is worse than the earlier overshoot of inflation is that it is easier to end excessive inflation as former Fed Chairman Volcker proved than to end deflation, as Japan’s 15-year struggle to do so has shown. 

ECB President Draghi has rebutted those who criticize the lack of a further cut since November’s by noting that 1) the policy already is very accommodative and 2) that officials also did not automatically tighten every time in earlier years when they met while inflation exceeded target.  The second point lacks some credibility because the risks of too much inflation are not as serious as the risks of too little inflation, and a third argument that measures of expected inflation show such still being anchored also isn’t compelling because expected inflation is merely a lagged function the trend in current inflation.  Measures of expected Japanese inflation failed to flag that country’s slide into deflation until it was too late. 

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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