Energy Prices Impact on Inflationary Spiral

Abstract

Energy constitutes an essential share of costs across any economy. The percentage of electricity in the overall energy consumption is steadily increasing. This increase, however, is not reflected correctly in the consumption basket relevant for measuring inflation and, therefore, for monetary policy formulation. We argue that the energy mix reflected in inflation should be revised in favour of electricity. We present an analysis of inflationary pressures across Europe and decompose the impact of energy categories on headline inflation. Building on the inflation expectations framework, this study examines the characteristics and magnitude of the current energy price dynamics and quantifies its share in the countries’ effective inflation. Our research also confirms a compelling insight into the country’s energy structure and inflationary pressures when a larger share of renewable electricity sources proves to be associated with lower inflation. Finally, we argue that the energy price shock cannot be viewed as a one-shot event as in the case of oil price shocks in the past. We draw recommendations for monetary policy formulation. The implication of renewable sources on inflation should be of interest to policymakers, especially in times of high, almost galloping inflation rates in some European countries, unstable fossil energy sources supply due to geopolitical instability, and climate crisis.

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