12 January 2016

Bruegel: Has ECB QE lifted inflation?

Euro-area headline inflation has remained close to zero since the ECB stepped up its APP in early 2015, but this does not mean that QE has been ineffective: core inflation and its adjusted version for the indirect effects of low oil prices have steadily increased throughout 2015.

Despite efforts by the European Central Bank (ECB), recent euro-area inflation figures continue to be low. Headline inflation in the euro-area has remained close to zero since early 2015, when the ECB started its expanded asset purchase programme (EAPP), otherwise known as quantitative easing (QE).

Guntram Wolff has shown that market-based inflation expectations fell from July to September 2015 and remained well below the ECB’s 2% inflation benchmark. Inflation expectations have hardly changed since then.

Some observers may take these developments as evidence for the ineffectiveness of the ECB’s QE, but such a view would be wrong. In this post I show that euro area core inflation, a measure of inflation which disregards price changes for more volatile items like food and energy, as well as its adjusted versions for low energy prices have steadily increased throughout 2015, when we use quarterly data, which filters out short term noise.

Focusing on energy prices is rather obvious. Energy price developments do not really depend on ECB monetary policy measures. Low energy prices impact inflation, and not just because energy products accounts for more than 10 percent of the total consumer basket used to calculate inflation.

Energy has indirect and second round effects on inflation too, and so falling energy prices exert a downward pressure on core inflation. [...]

Yet the magnitude of this effect is not clear-cut. The ECB suggested in December 2014 that the fall in oil prices accounted for 0.6 percentage point of the total 0.9 percentage point decline in core inflation from late 2011 to mid-2014.

It is puzzling that oil prices play such a large role, especially when compared to the US: Dae Woong Kang, Nick Ligthart and Ashoka Mody showed that core inflation fell much more in the euro area than in the US, while low oil prices had an impact in both economies. [...]

Both actual euro-area core inflation and the energy-adjusted core inflation increased throughout 2015. Energy adjusted core inflation increased somewhat more than core inflation, suggesting that second-round effects of low oil prices matter, though the quantitative impact is not so large (my estimate for the contribution of oil prices to the fall in core inflation from late 2011 to mid-2014 is also well below the above mentioned ECB calculation).

For the US, I also find that energy-adjusted core inflation is higher than actual core inflation in 2015.

If my simple regression is able to capture the tendencies correctly, then euro area core inflation and its energy adjusted version have increased steadily since early 2015, at least using quarterly figures.

Current and energy-adjusted euro-area core inflation rates are still well below the ECB’s 2% threshold and are also below US core inflation, but my analysis shows that the very low euro  area headline inflation rates cannot be used to argue for the ineffectiveness of ECB QE.

Full article on Bruegel

© Bruegel