Inflation rates have spiked in many countries recently. Most attention is focused on the US, where some measures of inflation have now reached 5%, but even in the euro area one can find instances of countries – notably Germany – where inflation is now at 3-4%, clearly above the 2% target of the European Central Bank (ECB).
The key question is now whether this increase in inflation will be temporary or permanent. To answer this, one needs to take into account two temporary factors that distort the picture: i) the increase in energy prices, which has a strong impact on headline inflation; and ii) the base effect due to the temporary fall in prices at the trough of the Covid-19 recession in 2020. If one corrects for both these distortions by looking at core inflation rates over 24 months (to eliminate the base effect), one finds that inflation remains below 2% in the euro area but is now established clearly above 2% in the US. The data from labour costs confirms this picture of a transatlantic divide: wages are falling in the euro area but increasing in the US at the fastest rate since 2007.