European Central Bank working paper estimates pandemic-era euro area inflation was driven by combined supply and demand shocks with policy contributing about 1.5 percentage points

The European Central Bank published a Working Paper analysing the drivers of the euro area’s 2021–2023 inflation surge using a Bayesian vector autoregression framework, concluding that inflation was driven by a mix of supply and demand factors rather than any single dominant cause. The paper finds that fiscal and monetary policy were accommodative and contributed to inflation, but were not the primary drivers, and it argues that energy-price dynamics reflected both supply disturbances and demand pressures. Headline inflation rose from below 1% in January 2021 to above 10% in October 2022, while core inflation peaked at 5.7% in March 2023. The model attributes about 1.5 percentage points of peak inflation to policy-related demand shocks (around 0.6 percentage points from fiscal policy and 0.9 percentage points from monetary policy, with similar contributions from conventional and unconventional tools), about 2.4 percentage points to genuine energy-supply shocks, and a further roughly 3 percentage points to non-policy demand and non-energy supply shocks. The paper also estimates that genuine energy-supply shortages accounted for around 15 percentage points of the 30% peak in euro area energy price inflation, with the remainder largely driven by demand-side forces. In a counterfactual exercise, tightening conventional monetary policy six months earlier would still have left inflation peaking at 8.5% instead of 10% and would have entailed substantial output losses, with average economic growth falling by 3.6 percentage points relative to the realised path.