The Bank of England published a staff working paper on the drivers of persistent and transitory inflation in the euro area after Covid. The paper finds that domestic supply shocks fed into the persistent component of inflation, pushing euro-area trend inflation above 2% to about 3% by 2022Q2. By contrast, domestic and global demand shocks mainly operated through the transitory component, with the inflation gap accounting for 85% of the post-Covid inflation surge. Using a model that splits macroeconomic variables into trend and cycle components and identifies shocks by persistence, geography and type, the paper also concludes that euro-area trend inflation fell from 2% to 1% between 2012Q3 and 2016Q1, mainly because domestic and global demand-side shocks weighed on the persistent component. On output, the baseline estimates indicate euro-area potential GDP growth slowed from 0.50% quarter on quarter in the early 1990s to 2005-06 to 0.24% since 2006. The paper also finds that allowing for time-varying volatility and fat-tailed shocks treats the Covid-era GDP collapse mainly as a transitory disturbance rather than a fall in potential output.
Bank of England2026-02-13
Bank of England working paper finds domestic supply shocks lifted euro area trend inflation to 3%, demand shocks drove 85% of post-Covid surge
The Bank of England published a staff working paper on euro-area inflation dynamics after Covid. It finds domestic supply shocks lifted trend inflation to about 3% by 2022Q2, while domestic and global demand shocks explain 85% of the surge through the inflation gap. The paper also estimates euro-area trend inflation fell to 1% in 2015 and potential GDP growth slowed markedly after 2006.