Research

Abstract:

We propose a novel tool to gauge price pressures resorting to circular statistics, the so-called inflation compass. We show that it provides a reliable indication of inflationary pressures in the euro area by focusing on key episodes of high and low inflation since the monetary union's inception. Unlike most alternative measures of underlying inflation, the inflation compass does not exclude any subitems of inflation, ensuring that all disaggregated information is taken on board. Moreover, it is not subject to revisions, providing policymakers with real-time signals about the course of underlying inflation, while being easily understood and visually appealing. We also provide evidence of the usefulness of the inflation compass to forecast overall inflation up to 36 months ahead, even during periods of increased turbulence, such as those marked by the COVID-19 pandemic or the recent inflation surge. Our findings indicate that the inflation compass surpasses other widely used measures of underlying inflation for the euro area, leading to statistically significant improvements in forecast accuracy. Lastly, we show that our approach can handle large-dimensional data by leveraging finer product-level and country-level data. In such an environment, the inflation compass still exhibits higher accuracy, underscoring its robustness and reliability.

Abstract:

The recent rise in inflation was initially driven by external shocks and restricted to some items, becoming increasingly entrenched over 2022. In this article, the role of price spillovers in the generalization of inflationary pressures is analysed. Spillover effects rose in the post-pandemic period and are more important for a longer period due to a higher transmission across sectors. This suggests that relative price changes are more likely to propagate to underlying inflation as they echo more into other components. The measure of common inflation built confirms this trend as it shows that co-movement across a large number of prices has been the main driver of headline inflation.

We investigate the pass-through of a Value-Added Tax (VAT) decrease to consumer prices, using Portugal's temporary cut in VAT for a subset of food items in 2023 as a laboratory. Exploiting a novel high-frequency dataset of online retail prices, we use an event study approach to analyze price dynamics across the complete policy lifetime. We find that prices rose by around 1% upon announcement, that the pass-through was almost complete when the policy was implemented, and that the pass-through was approximately 70% at the reversal of the policy. The price reduction was highly persistent over the entire duration of the policy. We estimate that the policy decreased month-on-month inflation by 0.7 percentage points. We find evidence of deflation in producer prices around the implementation, which could be a potential mechanism driving the high pass-through.

Abstract:

In this paper, we construct a proxy for uncertainty that tracks monetary policy in the Euro area by text-mining thousands of newspaper articles in the press. We calibrate a nonlinear interacted vector autoregression model to study the impact of monetary policy uncertainty on the real economy and on the effectiveness of monetary policy. We find that higher uncertainty leads to a contraction in economic activity, with a higher dampening effect in uncertain times. Uncertainty also influences how strongly movements in the policy rate affect output, investment and consumption as, in uncertain times, average responses are up to three times less powerful than in tranquil times.