Gas price shocks and euro area inflation

This paper develops a Bayesian VAR model to identify three structural shocks driving the European gas market: demand, supply, and inventory shocks. We document how gas price fluctuations have a heterogeneous pass-through to euro area prices depending on the underlying shock driving them. The pass-through is stronger and more persistent when gas prices are driven by aggregate demand or supply pressures, while inventory shocks have a weaker impact. Supply shocks, moreover, are found to pass through to all components of euro area inflation—producer prices, wages, and core inflation—which has implications for monetary policy. Finally, we document how the response of gas prices to shocks is non-linear and is significantly magnified in periods when the economy operates at capacity and, therefore, unemployment is low.