MONETARY POLICY REPORT | SUMMER 2022 (box 1)
(authors: Martin Kábrt, Luboš Komárek, Filip Novotný, Petr Polák, Michaela Ryšavá)
European and global inflation are breaking historical records but have likely yet to peak. The current growth in prices can probably only be compared to the decade of inflation that followed the oil price shocks of the 1970s or – in the case of the new EU Member States – to the growth in prices they experienced during their transition to a market economy in the 1990s. Although the current inflation is a global phenomenon, it varies visibly across countries. This box focuses primarily on Czech inflation in the European context. It aims to examine the differences in price growth more closely and offer possible explanations for them.[1]
While inflation in June reached double figures in 15 EU countries, including the Czech Republic (and even exceeded 20% in Estonia and Lithuania), it was still far below 7% in France and Malta and well short of 4% in Switzerland. Increased inflation can be the result either of a sharp rise in the prices of a small number of items, or of somewhat lower, but broad-based, price growth.[2] To what extent can the breadth of the rise in prices and, conversely, its intensity explain the current differences in inflation across countries?
The differences in breadth are obvious at first glance. On average only about one in five of the 256 items in the HICP consumer basket have risen in price by more than 10% year on year in the euro area, whereas the prices of more than half of the items are going up fast in the Baltic countries (see Chart 1).[3] Before Covid, the Baltic States were in a similar situation to the Czech Republic as regards the labour market, consumer demand, sentiment and the property market. Indeed, the Czech Republic is the infamous “winner” in terms of broad-based price growth, as almost two-thirds of the items in the Czech economy have gone up in price by more than 10%. At the other end of the scale are Switzerland and France, where the share of rapidly rising prices account for only around a tenth of the consumer basket items.
Chart 1 – There are significant differences in the breadth of inflation across European countries
shares of items in the HICP consumer basket in %; data for June 2022; source Eurostat, CNB calculation
The intensity of the growth in prices of individual items also plays an important role. The year-on-year price growth in the main consumer basket categories in Chart 2 shows that inflation in the countries under review was driven up mainly by growth in housing, energy and fuel, transport and food prices. However, the rates of price growth in these categories vary widely across countries. Energy prices for Hungarian consumers, for example, have risen by less than 12% since June 2021, while Belgian consumers are now paying 65% more. However, headline inflation is comparable in the two countries because the price growth in Hungary is much more broad-based (more than half of items went up by 10% or more in Hungary, as against only one in six in Belgium). In terms of the intensity of inflation, the Czech Republic holds several “first places”: in the area of hotels and restaurants (23.7%, i.e. almost 5 pp higher than Bulgaria in second place), in clothing and footwear (19.7%, i.e. some 8 pp higher than Croatia in second place) or in the recreation and culture category (12.2%, i.e. almost 2 pp higher than Poland in second place). None of these categories is directly associated with external shocks. Growth in prices of food, transport and energy – all items directly affected by the commodity crisis exacerbated by Russia’s invasion of Ukraine and supply chain disruptions – is only slightly above the European average in the Czech Republic, while for energy it is even below the average.
Chart 2 – The intensity of the growth in prices of individual consumer basket categories also varies across European countries
year-on-year growth in %; data for June 2022; colour scale indicates intensity of annual inflation; source Eurostat
Another way to distinguish extraordinary price effects from the rate at which price growth permeates the economy as a whole is to look at indicators of underlying inflation. These indicators use various statistical techniques to adjust headline inflation for volatile factors and thus more faithfully illustrate the medium-term inflation trend. The three indicators of underlying inflation in the Czech Republic[4] shown in Chart 3 differ little from headline inflation. They thus clearly show that inflation in the Czech Republic cannot be attributed solely to extreme swings in the prices of a few volatile items. For the Baltic countries, by contrast, the difference between headline inflation and the other indicators is considerable. The clearest example is Estonia, where inflation is only about half as high after adjustment for extreme price fluctuations. Despite the fact that the Baltic countries have higher headline inflation than the Czech Republic, the price pressures from the depths of the economy are stronger in the Czech economy. Hence, unlike in some other European countries, it cannot be said that the Czech Republic is merely experiencing growth in energy or food prices. Prices are rising broadly across categories and HICP items. The Czech Republic has not only the highest core and median inflation in the EU, but also the highest services and durables inflation (excluding energy).
Chart 3 – While several volatile items are driving inflation in some European countries, the price pressures in the Czech Republic are broad-based
various inflation indicators; y-o-y in %; data for June 2022; source Eurostat, CNB calculation
Note: Headline inflation is the HICP index. Core inflation is the HICP excluding prices of energy, food, alcohol and tobacco. The weighted median was used for median inflation. A trim of 10% was used for trimmed inflation.
Explaining the international differences in the intensity of inflation is generally easier than explaining those in its breadth. For example, the same global shock of rising fuel prices led to different increases in energy prices for consumers in different countries. This is linked to the country’s energy policy, the type of contracts concluded with fuel suppliers, the speed at which energy prices on exchanges pass through to retail prices, the ability of distributors to pass on costs to consumers, and of course government measures, which, by lowering indirect taxes or price caps, can directly influence prices for end customers.[5] The impact of growth in energy prices on headline inflation is also affected by the weight of energy in the consumer basket. Expenditure on energy represents only 5% of total household spending in Switzerland but a full 16% in Latvia. Similar differences are seen for food – the average Swiss household spends 16% of its total outgoings on food, while the average Latvian household spends 34%. A higher weight of rapidly rising items in the consumer basket naturally increases headline inflation in the country. The different intensity of the growth in prices may also be related to the initial price level. For example, there is a clear statistical relationship across countries between the 2020 price level and current inflation in restaurants and hotels, recreation and culture, for which the Czech Republic has the highest inflation in Europe.
The differences in the breadth of the growth in prices are more complicated, because they relate to the overall macroeconomic environment. Broader price growth generally signals a bigger role of demand-pull inflation pressures. However, data from the Czech national accounts show that Czech households’ real expenditure on durable goods in 2022 Q1 had not yet exceeded the pre-Covid level. The same is true for many other EU countries.[6] The picture is similar for services prices, where we do not see a link between the growth in prices of services and the intensity of the increase in real expenditure on services across the euro area countries.[7]
An analysis of the variability in the month-on-month rates for the sub-components of inflation in European countries furthermore reveals that there is a relationship between the similarity of the evolution of those sub-components (lower variability) and the level of core inflation. Lower variability of price changes in the individual consumer basket items, which indicates broader-based inflation, is accompanied by a higher inflation rate on aggregate. This is also true for the Czech Republic, where core inflation is even higher than in countries with a comparable level of variability. This evidence suggests that the broader and more intense growth of prices of goods and services in the Czech Republic is not driven primarily by increased demand itself, but rather by the willingness of consumers to accept higher prices in an environment where the labour market is tight and households have forced savings and a solid income situation. After the pandemic shutdowns ended, firms apparently took advantage of this willingness to make up for their lost profits. They continue to be able to pass on their growing costs to customers, and are doing so to a greater extent than would be consistent with the intensity of the growth in their costs.[8]
Support for the above hypothesis can be found by looking at the income side of households’ budgets instead of the expenditure side. Chart 4 shows that the difference in growth in households’ disposable income during the pandemic years (2020 and 2021) across countries explains one-third (0.32) of the cross-country differences in current core inflation. A similar relationship can be found between the current core inflation in European countries and the intensity of growth in their government debt in 2021, or between core inflation and the lead of wage growth over labour productivity. Generous fiscal and monetary stimuli probably contributed to the tight labour market, with many otherwise non-viable firms not forced to lay off staff. The Czech Republic has the lowest unemployment rate and one of the highest labour force participation rates in the EU. At the same time, Czech fiscal policy last year was one of the most expansionary, and the rise in government debt relative to GDP was one of the steepest and most sustained.
Chart 4 – Different household income growth during the pandemic explains one-third of the differences in current core inflation in European countries
horizontal axis: change in households’ disposable income in 2021 relative to 2019 in %; vertical axis: harmonised core inflation in %; average for 2022 Q2; source Eurostat and ECFIN (Directorate-General for Economic and Financial Affairs)
Note: The coefficient of determination (R2) of the linear regression is 0.32. This means that the independent variable on the horizontal axis explains one-third of the variability of the dependent variables on the vertical axis. Household disposable income data for 2021 Q4 is not yet available for some countries, so ECFIN estimates are used instead.
The measured correlations should be interpreted with a high level of caution. They are, however, consistent with economic intuition, according to which the external cost shocks have spilled over to across-the-board demand-pull price shocks. This has occurred in particular in countries where governments provided the public with greater fiscal stimuli, households were in a more robust financial position after the pandemic, and a long-term tight labour market contributed to wages rising faster than labour productivity.
The domestic, and hence demand-pull, origin of the broad-based price growth in the Czech Republic confirms that the CNB’s monetary policy response to date has been appropriate. However, in line with the forecast, many of the supply factors (commodity prices, tensions in global value chains, the labour market situation, developments in mark-ups) and demand factors (previous government fiscal measures, forced savings) driving up prices will probably subside. This will lead to a gradual decrease in inflation.
[1] For the purposes of comparing inflation across countries, this box uses the Harmonised Index of Consumer Prices (HICP), which, unlike the national CPI indices, uses the same inflation calculation methodology across countries. Unlike the Czech CPI, the HICP does not include the cost of owner-occupied housing (homeowners‘ imputed/hypothetical rent).
[2] The intensity and breadth of inflation in the Czech Republic was described in a box in MPR – Winter 2022.
[3] The Czech Republic’s five largest trading partners, the three countries with the lowest inflation and the three countries with the highest inflation were selected from all the countries under review (i.e. the European countries excluding Turkey) for the purposes of illustrative graphical comparison in Charts 1–3.
[4]In the calculation of trimmed inflation, the individual items of the consumer basket are sorted by price growth. The size of the “trim” of the two tails of the distribution is then selected, and trimmed inflation is calculated from the remaining items. Median inflation is an extreme form of trimmed inflation, as it trims everything except the weighted midpoint of the distribution.
[5] For example, the Hungarian government capped fuel prices last November and some food prices this February. Germany has slashed the cost of public transport (to EUR 9 a month) and cut fuel tax from June to August 2022. The Czech government has also dampened the rise in fuel prices by lowering excise duty on petrol and diesel by CZK 1.50 a litre from June (currently until September). A detailed and regularly updated overview of national measures, including tax changes, price regulation and other policies, can be found in Sgaravatti, G., S. Tagliapietra, G. Zachmann (2022), National policies to shield consumers from rising energy prices, Bruegel Datasets.
[6] The situation was rather different in the USA, where final consumption of durable goods is currently well above the 2019 level (by 25%). This increased demand was subsequently reflected in higher growth in durable goods prices in the USA (by 14.7% year on year so far in 2022 on average). The USA was therefore able to “vacuum up” durable goods from the global market, making them temporarily unavailable, pushing up their prices and causing related transport disruptions.
[7]; By contrast, the rise in services prices in the USA was visibly linked to growth in consumption of services.
[8] Despite the sharp increase in input and energy prices, the profit rate (the ratio of gross operating surplus to gross value added) is currently around the level seen during the period of solid economic growth in 2018–2019. The Monetary Department’s core forecasting model also indicates that current margins in the consumer sector are above the usual level.