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 Topic: European Macroeconomics & Governance

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

Opinion

Politics, not policy will help Lagarde save the eurozone

Her success at helm of Europe’s central bank will depend on her ability to mend fences with hawkish policymakers.

By: Guntram B. Wolff and Rebecca Christie Topic: European Macroeconomics & Governance Date: November 4, 2019
Read article More on this topic More by this author

Opinion

How to ward off the next recession

Despite confident official pronouncements, the deteriorating state of the global economy is now high on the international policy agenda. The OECD recently revised down its forecasts to 1.5% growth in the advanced G20 economies in 2020, compared to almost 2.5% in 2017. And its chief economist Laurence Boone warned of the risk of further deterioration – a coded way of indicating a growing threat of recession.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: October 2, 2019
Read article Download PDF

External Publication

European Parliament

Challenges ahead for the European Central Bank: Navigating in the dark?

Since the second half of 2018, signs of a slowdown have been piling up in the euro area. The ECB will face major challenges in this potentially difficult period: its main tools are nearly exhausted, the monetary union in which it operates is still incomplete, and it lacks the understanding of what the ‘new normal’ looks like. The authors, therefore, urge the ECB to review its strategy and framework to be able to face these challenges.

By: Grégory Claeys, Maria Demertzis and Francesco Papadia Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: September 25, 2019
Read article More on this topic More by this author

External Publication

La Banca centrale europea

This external publication delves into the new responsibility given to the European Central Bank: supervision on banks in the euro-area. It tells its history and illustrates its functions, structure and responsibilities and the exceptional answers to respond to the "perfect storm" of the crisis.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: July 31, 2019
Read article More on this topic More by this author

Blog Post

Croatia’s path into the banking union

Croatia seems a suitable candidate for euro area accession: there is a tight peg to the euro, high public debt is coming down, and the banking sector is already dominated by euro area banks. But the Eurogroup has rightly targeted reforms of the state’s role in the economy as a precondition for participation in ERM II and the banking union. None of the announced reform plans are new or easily concluded within the timeframe that has now been agreed.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: July 18, 2019
Read article More on this topic

Blog Post

‘Lo spread’: The collateral damage of Italy’s confrontation with the EU

The authors assess whether the European Commission's actions towards Italy since September 2018 have had a visible impact on the spread between Italian sovereign-bond yields and those of Germany, and particularly whether the Commission’s warnings have acted as a ‘signalling device’ for bond-market participants that it might be difficult for Italy to obtain the support of the ESM or the ECB’s OMT programme if needed.

By: Grégory Claeys and Jan Mazza Topic: European Macroeconomics & Governance Date: July 8, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Priorities for the new ECB president

In this Director's Cut of 'The Sound of Economics', Guntram Wolff talks to two of the authors of Bruegel's memo to the new ECB president, Maria Demertzis and Grégory Claeys, to specify the most important issues at the beginning of this eight-year cycle and to clarify the parameters within which the new incumbent will have to work.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 4, 2019
Read article Download PDF More on this topic

Policy Brief

Preparing for uncertainty

Memo to the president of the European Central Bank. Grégory Claeys, Maria Demertzis and Francesco Papadia present the challenges that the next ECB president will face during the upcoming mandate, reinventing monetary policy in a system riddled with uncertainties.

By: Grégory Claeys, Maria Demertzis and Francesco Papadia Topic: European Macroeconomics & Governance Date: July 3, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: ECB monetary policy decisions deconstructed

In this Director’s Cut, Bruegel’s Grégory Claeys and Maria Demertzis take a deeper look at whether the monetary policy decisions made by the ECB over the past three presidential eras arrived by consensus, by unanimity or by majority votes of the governing council.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 27, 2019
Read article More on this topic

Blog Post

The evolution of the ECB governing council's decision-making

Before it is decided who will chair the governing council for the next eight years, the authors look back and examine precisely how decisions have been taken since the ECB was created – by unanimity, by majority, or by consensus.

By: Grégory Claeys and Tanja Linta Topic: European Macroeconomics & Governance Date: June 27, 2019
Read article More on this topic More by this author

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 27, 2019
Read article More on this topic More by this author

Blog Post

Developing resilient bail-in capital

Europe’s largest banks have made progress in issuing bail-inable securities that shelter taxpayers from bank failures. But the now-finalised revision of the bank resolution directive and a new policy of the SRB will make requirements to issue such securities more onerous for other banks. In order to strengthen banking-system resilience, EU capital-market regulation should facilitate exposures of long-term institutional investors.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: April 29, 2019
Load more posts