How Do Supply Shocks to Inflation Generalize? Evidence From the Pandemic Era in Europe

We document how the interaction of supply chain pressures, elevated household inflation expectations, and firm pricing power contributed to the pandemic-era surge in consumer price inflation in the euro area. Initially, supply chain disruptions raised inflation, particularly in manufacturing, through a cost-push channel, while also elevating inflation expectations. In turn, higher inflation expectations appear to have lowered the price elasticity of consumer demand and strengthened firms’ pricing power, enabling even firms in service sectors that were initially unaffected by supply constraints to raise markups. Through this expectations mechanism, localized inflation in sectors sensitive to supply-side shocks generalized into broad-based inflation.