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A Sustainable Development of Inflation in Euro Area Requires Continuously Improving Labor Market

DIW Weekly Report 43 / 2018, S. 429-437

Geraldine Dany-Knedlik

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In the past five years, the inflation in the euro area has been well below the European Central Bank’s (ECB) aimed inflation rate of close to but below two percent for achieving its objective of price stabilization in the medium term. The present analysis shows that expectations of low inflation, rising cyclical unemployment, and external factors such as low crude oil prices were responsible. In the middle of this year euro area price development picked up again. At its meeting in June this year the Governing Council of the ECB decided to end the asset purchase programme (APP) by December of this year and held out the prospect of a first rise in key ECB interest rates after the summer 2019. This necessitates a continuing, sustained inflation momentum. However, core inflation excluding energy and food prices has remained relatively low until now. The ECB is primarily relying on increasing wage momentum to drive core inflation in the near future. As DIW calculations show, this relationship exists but it is quantitatively rather weak. For core inflation to support the medium term price stability in the upcoming years, wages must continue to grow considerably.

Geraldine Dany-Knedlik

Research Associate in the Macroeconomics Department

JEL-Classification: E5;E31;E24
Keywords: inflation dynamics, inflation expectations, passthrough unit labor costs,monetary policy, euro area
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