The euro area great inflation surge

How did inflation get so high, and what are its main drivers? This question is at the center of the academic and policy debate right now. Its answer is crucial for policy-making. In this note, we propose a narrative of the Euro Area inflation surge, supported by theoretical and empirical analyses. We show why the current debate, often solely focusing on energy prices, has at times failed to appreciate the complexity of what happened: demand and supply both contributed to output and inflation dynamics but their absolute (and relative) contributions have changed over time. The main result of this note is that while price pressures were already building before the natural gas shock, an inflationary impulse in one sector (energy) has quickly become broad based because demand conditions remained accommodative facing the negative supply shock. Our analysis also sheds some light on the ‘real time’ debate during the inflation surge period, regarding the broad-basedness of price changes, the persistence of the energy shock, and the idea that monetary policy should look-through supply shocks.