The euro at 25: how demand, supply and policy shocks contributed to inflation in the euro area countries

Abstract

This paper quantifies the contributions of various shocks and policies to the dynamics of inflation in the 12 founding members of the euro area during its first 25 years. The paper estimates Bayesian VAR models with six variables using quarterly data from 1999q1 to 2023q3. Sign restrictions are used to identify six underlying shocks. The paper presents historical decompositions for each of the 12 countries. First, all six shocks contribute to developments in inflation, but their relative importance varies over time and across countries. Second, demand shocks appear overall to be more important than supply shocks for the dynamics of inflation. Third, the contributions to inflation of monetary and fiscal policy shocks are substantial but vary a lot over time. Fourth, the contributions of various shocks to inflation exhibit many similarities across the euro area countries, though there are also noticeable differences, especially during economic and financial crises.

Keywords

• Inflation
• euro area
• fiscal policy
• monetary policy
• E31
• E52