Supply, or Demand, that is the Question: Decomposing Euro Area Inflation

This paper studies the recent trends in inflation in the euro area and estimates to what extent the current inflationary pressures are driven by demand expansion and by supply side disruptions. First of all, consumer price inflation is particularly pronounced in goods and less so in the case of services. Energy and food are the most relevant components of rising consumer prices, accounting for almost three-quarters of total headline inflation. The fact that price pressure comes mainly from sectors with a high import content, then, suggests that disruptions along international supply chains may play a key role. The paper then focuses on producer prices at sectoral level and presents a methodology to decompose the rise in inflation between supply and demand impulses. It finds that, in the present context, supply factors are the main driver of inflation and account for about 80% of the current increase in producer prices. This is particularly evident in industry and in each one of the manufacturing sectors with the highest price pressures. These findings imply that, if repairing supply-side problems and disruptions along supply chains is the priority, then promoting the right investment may be more urgent than cooling demand down.