It’s more painful on the Continent but more persistent and demand-driven in America.
Leo Tolstoy’s observation that “all unhappy families are unhappy in their own way” applies to the multidecade-high inflation being experienced by countries around the world. The headline inflation numbers are increasingly similar—around 8% in both the U.S. and Europe—but the causes, consequences and treatment remain quite different. In particular, the U.S. has higher underlying inflation—which is potentially more persistent and is appropriately being treated with aggressive monetary tightening. In contrast, more of Europe’s inflation is imported—which makes it more painful than U.S. inflation but also likely more transitory, and so the European Central Bank should follow a comparatively restrained response.
The U.S. has had about 3 percentage points more cumulative inflation than the euro area since the onset of the pandemic. But inflation peaked in March in the U.S. and is likely to continue drifting down, while inflation rates have been rising in Europe. In the first four months of the year, inflation rose at a 12% annualized rate in Europe compared with 9% in the U.S.
The comparatively large runup in inflation in Europe is largely because of the extreme increase in the price of natural gas, now around $27 per million British thermal units, which was nearly three times what it is in the U.S. Russia’s invasion of Ukraine raised food and energy inflation around the world, but these effects have been much sharper in Europe than the U.S.
Strip out the volatile food and energy components, and core inflation—which economists focus on because it is a better predictor of future inflation than the more volatile headline number—and a large gap emerges. Measured on a comparable basis, core inflation likely grew about 6.5% over the last year in the U.S. (we will get the exact number on Friday) while growing only 3.8% in the euro area.
Moreover, some of the excess core inflation in Europe is also imported from the U.S. Since the pandemic started, the U.S. has spent cumulatively an extra $600 billion on goods, which is roughly 4% of the world’s total annual goods consumption (assuming a third of global consumption is spent on goods). In contrast, Europe has spent below-trend amounts on goods over that period. High U.S. demand in conjunction with global supply-chain problems is driving up spending on goods all over the world.
Inflation in both the U.S. and Europe reflects a combination of supply and demand. Europe also had a substantial fiscal and monetary stimulus and similar dynamics around supply and demand during the pandemic. But with U.S. nominal gross domestic product about 2% above trend and euro area nominal GDP about 2% below trend, it is clear that excess demand is playing a bigger role here, while Europe probably still has some additional economic slack.
The labor market provides the most telling evidence that underlying, demand-driven inflation is higher in the U.S. The U.S. labor markets may be tighter than they have ever been, with record rates of quits and job openings. Nearly two jobs are available for every unemployed worker. Europe successfully kept its unemployment rate from rising much during the pandemic and also has high levels of job openings—but still not nearly as many openings as unemployed workers. Moreover, average hours are up in the U.S. as employers struggle to keep up with demand, while they are generally down in Europe. All of this is a big part of why nominal wages are growing at about 6% annually in the U.S., well above their prepandemic pace, while nominal wage growth in the euro area is running at about a 3% annual rate.
Inflation is more persistent and demand-driven in the U.S., but it’s more painful in Europe. American workers are falling behind, with inflation well above nominal wage growth. But the imported aspect of European inflation makes the cost-of-living crisis in Europe much worse because workers haven’t been able to offset it with faster nominal wage growth and large government transfers.
Both the U.S. and Europe have a combination of persistent domestic demand-driven inflation and transitory global supply-driven inflation, but the ratios are very different in the two economies. It would be a mistake for U.S. policy makers to overstate the degree to which inflation is global and neglect addressing the many U.S. specific causes. Conversely, Europeans should take a more measured approach and not overreact to the disproportionate amount of global inflation they are facing. Administering different treatments could make both families happier in the end.
