This is where the rising inflation is more broad-based
One question policy makers are grappling with is how much importance to assign to the rise in inflation, which has been far more acute than expected.
After all, 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 during the COVID shock were also unprecedented, so it is possible that more broad-based, demand-led inflation is also rearing its head.
“We last week introduced 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. Euro zone inflation also looks generalized. However, this is largely due to German data, which show a broad-based rise in inflation. There is relatively little indication of broad-based inflation overheating beyond Germany and the US.,” say analysts at the Institute of International Finance.
“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 elsewhere we use harmonized HICP baskets from Eurostat.
“We allow for changing weights over time, though these are gradual, so most of the variation in our indices reflects how narrow or broad inflation is.”
Exhibit 1 shows these indices for the US, the UK, Euro zone and Japan. Inflation generalization in the US exceeds any level seen since 2000 and continued to rise in Jan 2020 data for the US CPI.
Exhibit 2 shows the same screen for month- over-month inflation on a seasonally adjusted, annualized basis.
The reason we provide this additional perspective is because base effects can distort the picture from year-over-year data, especially given that COVID was such an unusual shock.
The message from our month-over-month screen is similar. The US is clearly overheating, with the Euro zone not far behind.
“We compare the level of generalization in Dec 2021 with that in Dec 2011, when the global economy was recovering from the global financial crisis and oil prices had also risen sharply.”
The US and Germany stand out as places with more broad-based inflation now than in 2011 (Exhibit 3), consistent with strong fundamentals pre-COVID, loose financial conditions now and strong overheating (Exhibit 4).
One question many ask is whether Germany’s VAT hike in Jan 2021 is driving generalization. Exhibit 5 shows our indices for Germany, where the latest data are for Jan 2022, when the base effect from Jan 2021 drops out.
Year-over-year generalization falls as expected, but month-over-month generalization remains high and rises, a sign overheating is genuine (Exhibit 5).
Exhibit 6 shows just how unusual the broadening out in German inflation is in longer historical perspective.
Of course, the ECB targets overall inflation, not just Germany. But Germany carries disproportionate weight in ECB decisions, which means that pressure to normalize ECB policy and resulting upward pressure on periphery spreads will continue.
