The great dispersion: euro area inflation differentials in the aftermath of the pandemic and the war

Differences in inflation levels between euro area countries have risen sharply to previously unseen levels. This has come alongside the recent surge in inflation in the euro area following the pandemic and the energy price shock triggered by Russia’s aggression of Ukraine. This article reviews the recent evidence on why inflation rates have differed so much across countries and discusses the potential implications for the euro area. Most of the differences are attributed to global factors, essentially commodity prices and supply disruptions, that led to inflation patterns that were on the one hand highly synchronised, but on the other hand very uneven in magnitude, reflecting structural differences in energy intensity. As the impact of these factors gradually fades, the impact of domestic country-specific drivers of national inflation is now increasing. The extent of future dispersion in inflation will thus largely depend on households’ and firms’ efforts and ability to safeguard purchasing power and profits by raising wages or prices. If inflation persists at national level, it could give rise to asymmetric inflation patterns across the euro area, depending on domestic institutions such as wage or price indexation mechanisms, or the tempering effect of income support provided in response to the various real income shocks on wages. Persistent and significant asymmetries could give rise to costly macroeconomic imbalances