The huge literature on the causes of the persistent weakness in inflation in the euro area has not identified one single key factor. Moreover, inflation has also been lower than expected in many advanced countries. Low inflation expectations seem to have played an important role in reducing wage demand, both in the US and the euro area; but a residual output gap also contributes. The concerns about low inflation seem overblown. The HICP (Harmonized Index of Consumer Prices) used to measure inflation in the euro area differs from the indices used in most advanced countries in that it does not account for the cost of owner occupied housing. This omission has a considerable impact on measured inflation and can explain most of the difference between inflation in the US and in the euro area. If the HICP were to incorporate the available estimates of inflation in owner occupied housing, measured inflation would be close to 2 %.
This project was awarded under the Framework Service Contract for the provision of external expertise in the field of monetary and economic affairs (Monetary dialogues) (IP/A/ECONMD/FWC/2014-026/C6) with the European Parliament. The full list of CEPS’ Framework Contracts is available here.