MNI INTERVIEW: Inflation Still Far From Normal - ECB's Arce

The euro area economy and inflationary dynamics are “still far away from a normal post-pandemic situation,” as supply-side shocks still resonate, the European Central Bank’s Director General for Economics at the Oscar Arce told MNI.

“We are still seeing the persistent effects of the chain of shocks. It is not only the pandemic but it is the pandemic plus the energy crisis the geopolitical uncertainty created by the war in Ukraine but also by the Middle East,” Arce told an MNI podcast, in which he discussed an ECB Occasional Paper on post-pandemic inflation.

“Wages are still growing quite fast, the labour market is still quite tight, profits, unit profits are still relatively high. Uncertainty about energy remains relatively high,” he said. “If you look directly at inflation, with services growing at 4%, clearly we are not yet in a normal situation.” (See MNI INTERVIEW: ECB's Wunsch Sees At Least Two Cuts By December)

In the paper, Arce and co-authors took a model for analysing inflation developed by former Fed president Ben Bernanke and Olivier Blanchard which teased out the impact of recent supply-side shocks and applied it to the eurozone. The model will add to the ECB’s analytical toolkit, particularly with regards to developing alternative scenarios, which the Bank has produced regularly since the pandemic and which have been very useful in communicating the implications of heightened uncertainty to both the public and to policymakers, Arce said.

BERNANKE-BLANCHARD MODEL

“ The way we build up our inflation forecast is quite different from just using a single model -- we look at a lot of information, we benefit a lot from the analysis and views and information coming from the national central banks of the Eurosystem,” together with using other tools, he said. “But this model, the Bernanke Blanchard model estimated for the euro area, for sure will be a very helpful tool, a very useful tool to crosscheck.”

Adjusting the model to take account of the eurozone’s structural differences, the authors found less labour-market overheating following the pandemic than in the U.S., though it also detected a significant impulse to recover wages’ lost purchasing power. Bottlenecks were a more persistent inflationary driver than the energy price shock which drove inflation in 2022 and the later food inflation, Arce said.

“What the model is telling us is not radically new… But it's very useful from the point of view of providing us some extra robustness to other analysis and tools”, he added.