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There's inflation and then there's inflation

A few weeks ago, the annual US inflation figure for June was released. The 9.1% rate was higher than what economists expected (8.8%). That same month, the inflation estimate for the Eurozone was 8.6%. These numbers don't seem to be all that different from one another. So, are the same things happening on either side of the Atlantic?

Not quite. The Eurozone has been much more heavily impacted by rising energy and food prices due to supply interruptions caused by the war in Ukraine.

This difference become clearer if we use another indicator of inflation, so-called core inflation.

What is core inflation?

We know that the inflation rate is an indicator of price increases. There are different ways of measuring this growth. One of the main differences lies in the composition of the 'basket' of goods and services used to calculate the change in prices during a specific period. Usually, when we hear about inflation, we are referring to the change in the price of a basket of goods and services that reflect the buying habits of an average consumer. Therefore, this basket also includes food and energy products, such as, for instance, petrol and diesel. The prices of these products can fluctuate greatly over time - technically they are 'volatile', that is, subject to larger swings in prices than other goods and services. The inflation rate used most often can therefore set off false alarms, confusing sporadic changes in the prices of certain goods with a more generalized price increase, which is much more important to the economy's performance.

For this reason, in order to obtain a less erratic inflation indicator, we need to exclude some products, such as food and energy, from the basket of goods and services used to measure price variation. This inflation rate, called core inflation, can provide economists with extremely useful information about the inflation trend.

In June, US core inflation, i.e. inflation net of the price trends in food and energy goods in the United States, was 5.9%, much higher than Eurozone core inflation of 3.7% (estimate).

Inflation in the Eurozone is above all an inflation imported from abroad due to factors related to how goods and services are supplied. In the United States, inflation has a larger domestic component, due to aggregate demand exceeding supply and higher labour costs.

Demand-pull inflation occurs when the demand for goods and services outstrips supply. In these cases, prices increase and only those able to pay more will see their demand satisfied. Demand can exceed supply because supply cannot increase as rapidly as demand. This is pretty much what is happening in the United States.

But price increases can be caused by supply-side problems, too. Just think of an increase in the prices of commodities that are necessary to produce a good - for instance oil, gas or electric energy. In these cases, businesses, in order to avoid reducing their profits in the face of rising costs, raise the prices of their products. Another example of inflation due to supply factors is when supply suddenly drops because of more or less temporary reasons, such as the war in Ukraine or the COVID restrictions, which cause interruptions in manufacturing and transportation issues.

In the Eurozone, it's more these kinds of supply-side factors, rather than a jump in demand, that are responsible for the rising inflation.

What will happen in the future? Only time will tell. Inflation is often a global phenomenon, like the increase in prices for commodities for instance, which in recent months has touched every country around the world, albeit not to the same extent. As of now, however, it seems that inflation is more likely to decrease in the Eurozone than in the United States.