The European Central Bank published Working Paper No 3138 by Luca Fosso presenting a trend-cycle vector autoregression framework to separate permanent (trend) and transitory (business-cycle) drivers of US macroeconomic fluctuations for policy analysis. The paper is published as research and does not represent the views of the ECB. The approach replaces deterministic long-run components used in standard structural VARs with time-varying stochastic trends and imposes theory-guided long-run comovement restrictions consistent with a New Keynesian framework and a Fisher relationship. Using quarterly US data from 1960Q1–2023Q4 on output, consumption, inflation, one-year-ahead inflation expectations, the three-month Treasury yield and commodity prices, the model produces gap measures and shock decompositions; it reproduces stylised facts such as lower trend growth since the 2000s and a secular decline in the real natural rate since the late 1990s. For the post-pandemic episode, the paper finds inflation was mostly cyclical with no evidence of trend inflation drifting away from a 2% target, and attributes the bulk of the inflation surge to demand shocks, with supply shocks important but largely confined to early recovery and the period around Russia’s 2022 invasion of Ukraine; accommodative monetary policy contributes to the surge and tightening contributes to disinflation. A real-time exercise suggests that adding inflation expectations reduces uncertainty and limits subsequent revisions to trend inflation estimates after 1982. A counterfactual specification that forces deterministic trends materially changes conclusions, producing persistently negative post-2008 output gaps and shifting the post-pandemic inflation surge towards supply-driven explanations.
European Central Bank 2025-10-14
European Central Bank working paper introduces trend-cycle VAR framework and finds US post-pandemic inflation mainly demand-driven with trend inflation anchored
The European Central Bank's Working Paper No 3138 by Luca Fosso introduces a trend-cycle vector autoregression framework to distinguish between permanent and transitory drivers of US macroeconomic fluctuations. Using data from 1960 to 2023, the study finds post-pandemic inflation was primarily cyclical, driven by demand shocks, with supply shocks significant during early recovery and around Russia's 2022 invasion of Ukraine. The paper highlights that accommodative monetary policy contributed to the inflation surge, while tightening measures aided disinflation.