Academic Literature

Inflation and Unemployment in US and Europe – The large drop in US core inflation is fully accounted for by sharply higher unemployment but it still a genuine puzzle in the Euro zone

• The years leading up to COVID-19 saw persistently low inflation, …
• something that came to be called by some the “missing inflation puzzle.”
• Rising unemployment and weak demand are now pushing inflation down, …
• though low inflation does not mean that something is automatically “missing.”
• We update our Phillips curve core inflation regressions for the US and Euro zone.
• The drop in US core inflation is entirely explained by sharply higher unemployment.
• In contrast, persistently low Euro zone inflation looks like a “missing inflation puzzle,” …
• given that the Euro zone labor market deterioration is so far comparatively benign.

The years leading up to COVID-19 were marked by persistently low inflation, something that came to be called the “missing inflation puzzle.” We have argued that low inflation needs to be seen in the context of key drivers, of which labor market and domestic demand dynamics are just one. The broad trade-weighted Dollar has risen 31 percent since end-2013, while oil prices have fallen 71 percent over the same period, forces that we have shown in past work exerted substantial downward pressure on core inflation. As such, we don’t see persistently low inflation as a “puzzle,” but as the inevitable outcome due to external shocks. COVID-19 is now drastically changing the inflation landscape. Core PCE inflation in the US is likely to fall to around 1.0 percent year-over-year in Q2 2020, down from 1.7 percent in Q1. Euro zone core inflation fell to 0.9 percent in Q2 2020, down from 1.1 percent in Q1. Against this backdrop, we update our Phillips curve regressions, which link core inflation to the unemployment gap and price moves in global currency and commodity markets. We find that the large drop in US core inflation is fully accounted for by sharply higher unemployment, while there looks to be a genuine puzzle in the Euro zone, given that the relatively benign labor market picture does not explain falling core inflation. In the big picture, the “missing inflation puzzle” continues to be in the Euro zone, not the US.

 

Chosen excerpts by Job Market Monitor. Read the whole story @ COVID-19 And The Missing Inflation Puzzle

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