Blog Post

Has ECB QE lifted inflation?

Euro-area headline inflation has remained close to zero since the ECB stepped up its quantitative easing programmes 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.

By: Date: January 12, 2016 European Macroeconomics & Governance Tags & Topics

Despite efforts by the European Central Bank (ECB), recent euro-area inflation figures continue to be low, as shown in Figure 1. 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.

Figure 1: Headline and core inflation, monthly data, 2007–2015 (% change compared to the same month of the previous year)

ZD_12_1_2016_FIG_1

Sources: Euro-area: “All-items HICP” and “Overall index excluding energy, food, alcohol and tobacco” from Eurostat’s Harmonised Index of Consumer Prices [prc_hicp_manr] dataset; US: “Personal Consumption Expenditures: Chain-type Price Index” and “Personal Consumption Expenditures Excluding Food and Energy: (Chain-Type Price Index)” from FRED (Federal Reserve Economic Data), Federal Reserve Bank of St. Louis. For the US, we use the price index of personal consumption expenditures because this is the indicator considered by the Federal Reserve as reported by James Bullard. The first vertical line indicates January 2015 when the ECB announced its expanded asset purchase programme, while the second vertical line indicates March 2015 when the programme started.

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. For example, the cost of transportation might fall, but more generally, lower energy prices reduce the costs of all producers, which may then reduce their sales prices in various sectors.

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 (see Box 3 in the December 2014 Monthly Bulletin).

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.

In order to assess the impact of oil prices on euro-area and US core inflation rates, I use a simple regression model: see the details in the annex. I use this model to calculate an adjusted version of core inflation. The indicator I call ‘core inflation adjusted for energy prices’. I aim to answer the question of what core inflation would be if inflation rate of energy goods was the same as core inflation.

Both actual euro-area core inflation (red line) and the energy-adjusted core inflation (blue line) increased throughout 2015, as shown in Figure 2. 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.

Figure 2: Core inflation and its adjusted version, quarterly data, 2007 – 2015 (% change compared to the same quarter of the previous year)

ZD_12_1_2016_FIG_2

Source: core inflation is from Eurostat/St Luis FED, adjusted core inflation is my calculation (see Annex). The vertical line indicates the first quarter of 2015 when the ECB launched its expanded asset purchase programme.

Annex: the regression

I study the developments of the annual percent change in euro area core inflation defined by Eurostat as an “overall index excluding energy, food, alcohol and tobacco” that I call “core inflation”.

For the USA, I use the annual percent change in ‘Personal Consumption Expenditures Excluding Food and Energy: (Chain-Type Price Index)’.

My aim is to calculate a counterfactual indicator that I call “core inflation adjusted for energy prices”: what would core inflation be if energy goods inflation rate was the same as core inflation?

To this end, I convert the data from monthly to quarterly frequency (to reduce the short-term noise in the data) and estimate a Phillips-cure-type regression for core inflation:

ZD_12_1_16_EquationV2

where ZD_12_1_2016_Equation2 is core inflation,ZD_12_1_2016_Equation3 is the unemployment rate, ZD_12_1_2016_Equation4 is the so-called non-accelerating inflation rate of unemployment (NAIRU, estimated by the OECD, see Figure 3), ZD_12_1_2016_Equation5 is the inflation rate of energy goods in the consumer price index,  ZD_12_1_2016_Equation6 is the error term and ZD_12_1_2016_Equation7 are parameters to be estimated. I allow lagged values up to four quarters (i.e. one year), because it can take time till unemployment and energy prince inflation can influence core inflation, while my general specification allows rich dynamic interactions between the variables.

I estimate this regression on quarterly data between 1999 and 2015. After estimating the regression, I calculate a counter-factual simulation for core inflation by setting the gap between energy and core inflation to zero throughout the sample period.

Starting from the 1999Q1 actual value of core inflation, I iterate the above equation using the estimated values of the parameters, the actual gap between the unemployment rate and NAIRU and the estimated error term (which captures all factors which are not included in the regression).

Certainly, one could use more sophisticated models, yet I believe this simple setup is able to provide useful results.

Figure 3: Unemployment rate and the NAIRU, quarterly data, 1999 – 2015 (%)

ZD_12_1_2016_FIG_3

Sources: Unemployment rate: Eurostat’s Unemployment rate by sex and age [une_rt_m] database; NAIRU (non-accelerating inflation rate of unemployment): OECD’s Economic Outlook No 98 (November 2015), which is available at the annual frequency: I converted the annual NAIRU estimates to the quarterly frequency.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Marek Dabrowski

Core and periphery: different approaches to unconventional monetary policy

Compared with the ‘core’ of the world economy, emerging markets have limited room for manoeuvre when it comes to applying unconventional monetary policy measures.

By: Marek Dabrowski Topic: Global Economics & Governance Date: May 24, 2016
Read article More on this topic

Blog Post

Pia Hüttl
Silvia Merler

Sovereign bond holdings in the euro area - the impact of QE

Since the announcement of the QE programme by the European Central Bank (ECB) on 22 January 2015, national central banks have been buying government and national agency bonds. In this post we look at the effect of QE on sectoral holdings of government bonds, based on our recently updated dataset.

By: Pia Hüttl and Silvia Merler Topic: European Macroeconomics & Governance Date: May 19, 2016
Read article More on this topic

Opinion

fratzscher-03
Reint_Gropp_m
p2-Kotz
jan-pieter-krahnen
odendahl-june14-1409577172
Beatrice Weder di Mauro
Guntram B. Wolff

Mere criticism of the ECB is no solution

What would happen if the ECB failed to respond to the excessively low inflation and the weak economy? And what economic policy would be suitable under the current circumstances, if not monetary policy?

By: Marcel Fratzscher, Reint Gropp, Hans-Helmut Kotz, Jan Krahnen, Christian Odendahl, Beatrice Weder di Mauro and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 10, 2016
Read article More on this topic

Opinion

Agnès Bénassy-Quéré
Guntram B. Wolff

ECB decisions put lack of fiscal union in the spotlight

Fiscal policy in the euro area is hardly supporting the recovery and the ECB. The EU needs a a proper fiscal union in order to stabilise the economy and inflation. We see four main avenues for achieving a viable fiscal framework.

By: Agnès Bénassy-Quéré and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 30, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

ECB TLTRO 2.0 - Lending at negative rates

On Thursday, the ECB surprised observers by announcing a new series of four targeted longer-term refinancing operations (TLTRO II) to be started in June 2016. The incentive structure of the programme has changed: on one hand, this TLTRO II could be the first case of lending at negative rates; on the other hand, the link with lending to the real economy might have been weakened.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: March 11, 2016
Read article More on this topic

Blog Post

Francesco Papadia
Guntram B. Wolff

Central banks: from omnipotence to impotence?

Like the price of financial assets, the market assessment of the capacity of central banks to achieve their price stability objective fluctuates between omnipotence and impotence. We do not agree with this binary view of the world and we examine in this post the case of the European Central Bank (ECB). We argue that the ECB still has some instruments left. It should consider moving beyond increasing sovereign debt purchases, which would be ineffective and pose risks. More important is to step up work on structural and fiscal policies.

By: Francesco Papadia and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 2, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The impotency of central banks

What’s at stake: The negative market reaction to the latest efforts to provide further monetary stimulus has generated an important discussion on whether central banks have lost credibility in their abilities to fight downside risks and shore up economies.

By: Jérémie Cohen-Setton Topic: Global Economics & Governance Date: February 22, 2016
Read article Download PDF More on this topic

Policy Contribution

WhIch fiscal union for the euro area?

Which fiscal union for the euro area?

At the current level of political and societal integration, a large federal budget is unrealistic in the euro area. The authors make three recommendations that would lead national fiscal policies to be more stabilising with respect to the economic cycle, while achieving long-term sustainability. They also recommend a move towards a European unemployment insurance scheme targeted at ‘large’ shocks, and a minimum set of labour-market harmonisation criteria.

By: Agnès Bénassy-Quéré, Xavier Ragot and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: February 18, 2016
Read article Download PDF

Policy Contribution

The European Central Bank’s quantitative easing programme: limits and risksEuropean Parliament

The European Central Bank’s quantitative easing programme: limits and risks

The ECB has made a series of changes to its QE programme in order to expand the universe of purchasable assets and have more flexibility in the execution of the programme. However this might not be enough to sustain QE throughout 2017. The extension of the programme also raises questions about its potential adverse consequences.

By: Grégory Claeys and Alvaro Leandro Topic: European Macroeconomics & Governance, European Parliament Date: February 15, 2016
Read article Download PDF More on this topic

Policy Contribution

Should the ‘outs’ join the European banking union?

Should the ‘outs’ join the European banking union?

This paper analyses the banking linkages between the nine ‘outs’ and 19 ‘ins’ of the banking union. It finds that the out countries could profit from joining banking union, because it would provide a stable arrangement for managing financial stability.

By: Pia Hüttl and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 4, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Oil and stock prices

What’s at stake: The recent positive link between oil and stock prices has been puzzling for most observers. While a decrease in the price of oil was traditionally seen as a net positive for oil importing countries such as the United States, the concurrent declines in the price of oil and the US stock market suggest that the relationship may be different in the current environment.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: January 25, 2016
Read about event

Past Event

Past Event

The Bank of England in Europe: Does EU membership constrain non-Euro central banks?

The ECB and its response to crises in the euro area have been in the spotlight recently. But how does EU membership affect the central banks of non-Euro member states? This question is especially pertinent in the UK, whose relationship with the EU is at a vital crossroads.

Speakers: Jon Cunliffe, Matt Holmes, Sheri Markose and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 22, 2016
Load more posts