These forces, which are partly external and partly domestic, have masked the relationship between economic slack and inflation, and have been reinforced by a weakening of inflation expectations. 2 1/5  BIS central bankers' speeches  Forces slowing down inflation in the euro area economy2 The euro area recovery has been characterised by a disconnect between economic activity and inflation – which some have referred to as a “missing inflation puzzle”. This disconnect becomes visible, for instance, when comparing actual growth and inflation outcomes for 2016 with those anticipated in the ECB staff macroeconomic projections of March 2014. The real GDP growth rate, which stood at 1.7% in 2016, essentially confirmed the March 2014 projection. HICP inflation, by contrast, turned out to be more than 1 percentage point below the rate projected in March 2014; and measures of core inflation, which strip out the direct disinflationary impact of the collapse of commodity prices over this period, have remained at 0.9%, about half the rate projected earlier. This picture points to pronounced disinflationary forces that have confounded attempts to forecast the impact of improved economic conditions on inflation. Where do these forces come from? Do they pertain to cyclical influences that monetary policy can offset? Do they reflect broader structural shifts in the economy that the central bank is forced to watch as a bystander?
Technological advancements, while also reducing distribution costs, can limit firms’ pricing power by facilitating price discovery by customers. For example, the advent of online retail platforms has greatly increased price transparency among consumers as the share of people searching for information online has risen continuously in the euro area. The downward pressure on mark-ups and, hence, prices associated with the spread of e-commerce is consistent with an erosion of euro area firms’ profit margins, which did not return to their pre-crisis levels until late 2014. Empirical analysis does not, however, find robust evidence that mark-up shocks have been a particularly dominant determinant of disinflationary tendencies since the crisis. In any case, these forces are only temporary: they can move inflation away from its long-run trend, even for a protracted period of time, but cannot affect trend inflation itself, unless they infiltrate inflation expectations. It is through inflation expectations that shocks to the inflation formation process which would otherwise have no relevance for a central bank can become a monetary policy problem. This brings me to the third element in the Phillips curve – its intercept – which is determined by inflation expectations. Inflation expectations In normal conditions, longer-term inflation expectations should be unaffected by transitory shocks, which typically dissipate over the medium term. However, recurrent shocks leading to a protracted period of low inflation can be misinterpreted as a lasting decline in trend inflation, and could jeopardise public faith in the central bank’s commitment or ability to deliver on its objective.