For that reason, they became relevant for our monetary policy. 2  BIS central bankers’ speeches  The role of domestic inflation These global factors, however, have by no means been the only force driving disinflation in the euro area. If we decompose inflation in the euro area and the United States, a striking difference is that, at least until the start of this year, domestic factors explain a much more important part of our disinflationary trend (Figure 3). This stronger role for domestic forces in the euro area has contributed to core inflation diverging from some other advanced economies. It has hovered consistently around 1% since mid-2013 (Figure 4). The ECB’s objective is headline inflation, and there are good reasons for this, not least to keep purchasing power stable. Headline inflation is also a better predictor of short-term inflation developments. But core inflation has to be taken into account because it is more closely linked to medium-term inflation trends. In fact, ECB staff analysis shows that core inflation is a better predictor of medium-term headline inflation than headline itself. Persistently low core inflation is therefore a risk to our mandate. So why have domestic factors affected inflation more in the euro area? The main reason is that, from 2011 onwards, the euro area experienced a sovereign debt crisis and a double-dip recession, while other advanced economies recovered (Figure 5). That led to a very prolonged downturn, which was associated with a decline in employment, depressed wage growth, and low business and consumer confidence.
Measures of global economic slack are good predictors of national inflation in advanced countries, as shown empirically e.g. by C. Borio and A. Filardo (2007), “Globalisation and inflation: New cross-country evidence on the global determinants of domestic inflation” BIS WP no. 227; and in New Keynesian open economy models e.g. by R. Clarida, J. Gali, and M. Gertler, (2002) “A Simple Framework for International Monetary Policy Analysis,” Journal of Monetary Economics 49: 879–904. BIS central bankers’ speeches  1  driving disinflation, and a notable increase in global shocks. Those global shocks are, however, overwhelming associated with oil and commodity price falls (Figure 1). As is well-known, global factors linked to oil and commodities should not, in principle, have any effect on price stability over the medium-term. They may have a lasting impact on the price level, but not on the rate of change of prices. All things being equal, lower prices for oil should, over time, lead to higher prices elsewhere as disposable income increases and overall demand from consumption and investment rises. In light of this, central banks typically choose to “look through” such global forces until their effect on inflation fades out or until prices reverse. As oil and commodity prices swings have opposing effects on output and inflation, monetary policy usually does not want to overreact and reinforce the effect on growth, in either direction.