EU, US, UK: A Tale of Three Inflations

In both the US and the Euro Area there is little sign of broad-based inflation pressures. The UK, by contrast, seems to have a more standard inflation problem
Number: 42
Year: 2023
Author(s): Pietro Galeone, Daniel Gros

The US and the euro area have similar headline inflation rates, but very different drivers. In the US, inflation is mainly driven by housing costs. By contrast in the euro area energy now provides an important negative element, that is offset to a large extent by still increasing food prices

Favero 2

Over the past two years, inflation has roared back globally after many years of low-flation, which had kept central banks struggling for ways to stimulate the economy, resorting ever more to unconventional measures. As Covid hit and lockdown measures stopped the economy, price pressures fell even more, with some inflation gauges turning negative.

The world’s major central banks engaged in further monetary stimulus – e.g. the Pandemic Purchase Program (PEPP) in the Euro Area and similar measures in the US and the UK.

The pandemic recession had a particularly pronounced impact on energy prices. For example, the price of crude oil even turned negative for a few days in March of 2020.

But the Covid shock was temporary. As lockdowns were eased in most Western countries, in the second half of 2020 and throughout 2021, the economy jumped back quickly, more so than anticipated thanks to huge fiscal stimulus enacted almost everywhere.

The snapback of demand was so quick and staggered across countries that global supply-chain could not keep up. Bottlenecks led to shortages and price hikes for industrial goods (see Figure 1). Energy prices also quickly rose again. Crude oil prices, for instance, reached pre-pandemic levels by the end of 2020 and surpassed them throughout 2021.

inflation fig 1

Figure 1: Global Supply-Chain Pressure Index. Source: Federal Reserve Bank of New York

Already before the Russian invasion of Ukraine, therefore, energy prices and the reopening-up of the economy were providing a strong upward push to inflation. The outbreak of the war then created another jolt for energy prices, especially for natural gas in Europe.

Central banks thus argued that they were fighting a cost-push inflation about which they had little control. But a closer look at the figures shows that the inflation stories in the three major Transatlantic areas (the US, the Euro Area and the UK) began diverging already then and have become rather different now.

In all three economies considered, inflation peaked at close to 10% in the second half of 2022. But the drivers differed. In the Euro Area inflation was mostly due to higher energy and, later, food prices. In the US and in the UK the prices of non-energy non-food items were more important. This is apparent in the three panels of Figure 2 that shows three major contributors to overall consumer price inflation: energy, food and the rest (services and non-food or energy goods).

Favero 2
inflation fig 3
snowball

Figure 2: Contributions to inflation dynamics. Source: OECD.

So where do we stand today? The pandemic is now fully behind us, supply chain pressures have eased (see Figure 1), and energy prices are back to pre-war levels, thus showing a fall relative to last year.

Figure 3 decomposes headline inflation for the last data available (October 2023) including, in addition to the three components used above, one additional item that explains part of the recent divergence, namely housing.

Bassini 3

Figure 3: Composition of October 2023 headline inflation rate. Note that since energy inflation is negative in all three cases, the bar “All Other” is given by the sum of blue-striped and grey bars, so that energy inflation is subtracted by all other items to make the total height of bars match headline inflation. Sources: BLS for the US, Eurostat for EA, ONS for the UK.

Bars in Chart 3 show that the US and the euro area have similar headline inflation rates, but very different drivers. In the US, inflation is mainly driven by housing costs (which may be partly due to how housing is measured in the US).

By contrast in the euro area energy now provides an important negative element, that is offset to a large extent by still increasing food prices. The UK has a higher inflation rate, with a more standard composition in that ‘all other items’ provide the biggest element.

What do these differences imply going forward? In both the US and the Euro Area there is little sign of broad-based inflation pressures. If energy prices remain constant, and food prices stabilize, inflation might soon return to close to the canonical 2% target.

The UK, by contrast, seems to have a more standard inflation problem with broad-based price pressures that still have to be contained.

A previous different version of this article is published by The Conversation

IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.