How Do Supply Shocks to Inflation Generalize? Evidence from the Pandemic Era in Europe

Abstract

We document how supply-chain pressures, household inflation expectations, and firm pricing power interacted to induce the pandemic-era surge in consumer price inflation in the euro area.Initially, supply-chain pressures increased inflation through a cost-push channel and raised inflation expectations.Subsequently, the cost-push channel intensified as firms with high pricing power increased product markups in sectors witnessing high demand.Eventually, even though supply-chain pressures eased, these firms were able to further increase markups due to the stickiness of inflation expectations.The resulting persistent impact on inflation suggests supplyside impulses can generalize into broad-based inflation via an interaction of household expectations and firm pricing power.

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