The ferocity of the global inflation rebound
The ferocity of the global inflation rebound has come as a surprise with central banks struggling to disentangle if this is a broad-based rise rather than relative price changes from energy and supply chain disruptions.
“We develop new inflation generalization indices for the major G10 economies, which measure the combined weight of items in CPI baskets with high inflation.
“The rise in US inflation is unparalleled in recent history and very broad-based. Oddly, given large output gaps, rising Eurozone inflation is also broad-based, Something that is driven by substantial overheating in German inflation,” says the Institute of International Finance.
The global policy response during COVID was unprecedented, both in terms of speed and scale. One of the questions policy makers are now grappling with is how much weight to place on the resulting rise in inflation, which has been far more acute than expected.
There are plenty of reasons to think high inflation is temporary, given supply disruptions and elevated energy prices, especially around geopolitical tensions in Europe. But fiscal stimulus and the degree of monetary accommodation were also unprecedented, so it is possible that more broad-based, demand-led inflation is also at play.
“We develop new generalization indices, which measure how broad-based the rise in inflation is across countries. The rise in US inflation is very broad-based to an extent that is unprecedented in recent history.
“Though this doesn’t address how persistent high inflation will be, it does lean away from relative price changes in favor of broad, demand-led inflation. To our surprise given large output gaps, Eurozone inflation is also very generalized, which is led by overheating in Germany,” say analysts.
Near historic highs
“We calculate the combined weight of items in standard CPI baskets with year-over-year inflation above two percent. For the United States, we do this both for the CPI and PCE baskets, for Japan for the CPI and everywhere else we use harmonized HICP baskets published by Eurostat.
“We allow for changing weights over time, though these changes are gradual, with the bulk of variation in our indices reflecting how narrow or broad inflation is. Exhibit 1 shows these indices for the US, the UK, the Euro zone and Japan,” the report says.
Inflation generalization in the US exceeds any level seen since 2000. Much of that rise is due to goods inflation, though services generalization has also risen to near historic highs (Exhibit 2). One surprise – given our view on still large output gaps – is the rise in Euro zone inflation generalization.
Exhibit 3 shows that this rise is just as apparent in month-over-month inflation when we seasonally adjust and annualize, so that base effects are unlikely to be a driving factor.
This rise in Euro zone generalization looks linked to Germany, where the rise in broad-based inflation is especially acute and parallels the US.
“We compare the level of generalization in December 2021 with that in December 2011, when the global economy was recovering from the global financial crisis and commodity prices were also up lots. The US and Germany stand out as places with more broad-based inflation, consistent with solid fundamentals going into COVID and ongoing very loose financial conditions during the recovery (Exhibit 4).”
“One question we get a lot is whether Germany’s VAT hike in in January 2021 could be driving inflation generalization. Exhibit 5 shows our inflation generalization indices for key Euro zone economies based on year-over-year inflation, while Exhibit 6 shows the same thing using month-over-month data.”
It is clear that inflation generalization in Germany remained high through all of 2021, which leans more in the direction of demand-led inflation than VAT hike effects. Of course, the ECB targets overall inflation, not just that in the Germany.
But – realistically – Germany does carry disproportionate weight in ECB decision making, which means that pressure to normalize ECB policy and resulting upward pressure on periphery spreads will continue.
