A key challenge for policymakers is to be able to separate persistent changes in price pressures from changes that are large but ultimately short-lived. Headline inflation is the aggregation of the changes in hundreds of prices of products that are part of household consumption expenditure. Underlying inflation is based on a subset of these changes that are thought to contain information about potential future inflation developments. A good measure of underlying inflation should be less volatile than headline inflation, unbiased, and capture the trend, so that headline will tend to adjust towards underlying inflation (Roberts, 2005).
One widely used estimate of underlying inflation is the core inflation rate, an exclusion-based measure, which removes energy and food-related items in the consumer basket. This works well when temporary fluctuations in commodity prices are the main source of volatility in inflation, but may understate price pressures when there are large fluctuations in a broader range of goods and services.
Trimmed-mean inflation is an alternative measure of underlying inflation pressures. This approach is purely statistical and aims to remove the most extreme price changes on both sides of the distribution of price changes each month, and then to compute mean inflation from the remaining items. While core inflation always removes the same products, those considered to have inherently volatile prices, the trimming eliminates the most extreme price changes in every period, which may involve taking out different items each month.
One practical difficulty is determining the optimal degree of trimming: removing too few items could leave excessive volatility, while removing too many could reduce the usefulness of the measure and push trimmed-mean inflation away from the (unobserved) trend in inflation (Dolmas and Koenig, 2019).
Trimmed-mean measures are widely used by the major central banks, but there is no consensus on the optimal degree of trimming. For example, in the United States the Federal Reserve Bank of Cleveland (2021) trimmed-mean CPI inflation estimate removes 8% of the weight on each side of the distribution, and the Federal Reserve Bank of Dallas (2021) trimmed-mean personal consumption expenditure inflation measure is asymmetric, with 24% of the weight from the lower tail and 31% of the weight in the upper tail being trimmed. The Bank of Japan (2021) and Bank of Canada (2021) have been using a symmetric trimming of 10% and 20% at the top and bottom of the distribution, respectively. The European Central Bank (ECB) does not systematically publish trimmed-mean inflation numbers but has been recently using a symmetric 7.5% trimming (ECB, 2021).
The measures below use a symmetric trimming of 10% at the top and bottom of the distribution to facilitate comparisons across countries, and to reduce the difference with a 36-month average inflation rate (which is used as a reference estimate for trend inflation).
Both core and trimmed-mean inflation are less volatile than headline inflation (Figure 1.22). They usually move in a similar fashion when the most volatile items are food and energy products. During the first phase of the pandemic, headline inflation declined substantially, but a comparison between core and trimmed-mean inflation reveals different drivers across countries. More recently, trimmed-mean inflation has been weaker than headline inflation (except for Japan) but on an upward trend, pointing to a gradual broadening of underlying inflation pressures.
In the United States, trimmed-mean inflation barely moved in 2020 while core followed headline inflation. The observed deceleration in headline inflation in 2020 thus came from a limited number of items not related to food and energy, most likely related to sanitary restrictions on some services.
More recently, annual trimmed-mean inflation has increased quite sharply to 4.1% in October 2021.
Core inflation also moved up to 4.1% in October after having stabilised at around 3.6% in the previous four months. These developments suggest that the rise in prices has become more broad-based in recent months.
Figure 1.22. Trimmed-mean estimates of inflation pressures are now rising
Year-on-year percentage changesNote: Data are for the personal consumption expenditures deflator for the United States; consumer price inflation for Japan; and harmonised consumer price inflation for the euro area and the United Kingdom. Trimmed-mean inflation trims 10% in terms of weights at the top and bottom of the distribution of the year-on-year growth of prices. Core inflation excludes energy and food-related products.
Source: OECD Economic Outlook 110 database; Bureau of Economic Analysis; Japan Statistics Bureau; Eurostat; Office for National Statistics;
and OECD calculations.
StatLink 2 https://stat.link/xyjak8
In Japan, trimmed-mean inflation has usually been above core inflation since 2020, in a period of low headline inflation. This suggests that a small number of components with a large negative inflation rate, outside of food and energy, are holding down headline inflation. Trimmed-mean inflation, which excludes those items, has risen to 1.2% in October.
In the euro area, during the pandemic core and trimmed-mean inflation were similar, as the same components were removed in both measures. More recently, headline inflation has risen by more than both underlying inflation measures, highlighting the role of higher food and energy costs.
However, underlying inflation has also risen, with trimmed-mean inflation reaching 2.4% in October.
In the United Kingdom, in 2020, as the pandemic hit the economy, headline inflation fell while core inflation remained more stable, the trimmed-mean measure being in the middle. This suggests that some domestic sectors as well as food and energy products had extremely low inflation rates. More recently, trimmed-mean inflation increased to 3% in October, pointing to rising underlying inflation pressures.
Figure 1.23. The pandemic triggered a shift in consumption from services to goods, especially in the United States
Real household consumption expenditures
Note: In Panel B, the data are an average of euro area member countries weighted by nominal consumption expenditures. Non-durable goods incorporate semi-durable goods. Services and non-durable goods are available only for Austria, Estonia, Finland, France, Germany, Ireland, Italy, Latvia, Luxembourg, the Netherlands and Portugal. 2021Q3 data are available only for France, Germany, the Netherlands and Spain.
Source: Bureau of Economic Analysis; Eurostat; and OECD calculations.
StatLink 2 https://stat.link/17vxw3 Risks remain that the combination of supply factors that have contributed to the gradual tightening of energy markets could persist and push up global energy prices further over the projection period (Box 1.2).
A rise in energy prices reallocates income between producers and consumers. Higher energy prices raise production costs, leading to some energy-intensive capacity being scrapped, and push up consumer prices in all economies, but export revenues will rise, and so may investment, in energy-producing countries. The net impact of rising energy prices on global activity is expected to be negative, however, as the propensity to consume of energy importers is typically higher than that of energy producers.
Simulations using the NiGEM macro-model illustrate the implications of a further 30% rise in world oil, gas and coal prices, starting in the first quarter of 2022. The shock is assumed to be sustained for three years, before fading gradually thereafter. In the first two years of the shock, consumer price inflation is pushed up by around 0.9 percentage points per annum on average in the OECD economies, and by 1¼ percentage points per annum elsewhere (Figure 1.25). GDP growth declines in the OECD economies by a little over 0.3 percentage points per annum in the first two years, with smaller net declines in the non-OECD economies reflecting a balance between stronger growth in the energy-producing economies and deeper declines in the major importing economies. Global carbon emissions are pushed down initially due to reduced use of carbon-intensive energy, but this effect fades in the absence of a sustained price change.
Monetary policy reacts to the upturn in inflation with policy interest rates raised by around 1 percentage point on average in the first two years in the major advanced economies before returning towards baseline as inflationary pressures subside.8
8 A variant, in which monetary policy in the advanced economies reacts in the first year of the shock by reducing asset purchases rather than by raising policy interest rates, makes only marginal difference to the balance of the results, but lowers the extent to which policy interest rates move above baseline in the second year.
70
Figure 1.24. Food, transport and housing account for a larger share of the budgets of lower-income households
Shares of household budgets accounted for by food, housing and transport, by income quintile
Note: Final consumption expenditures by uses. The OECD represents the unweighted average of shares of Australia (for 2017), Canada (2019), Czech Republic (2017), France (2016), Ireland (2016), Israel (2017), Mexico (2018), Netherlands (2017), New Zealand (2015), Slovenia (2018), Sweden (2015), United Kingdom (2017) and United States (2016).
Source: OECD Distributional Information on Household Income, Consumption and Saving database (experimental); and OECD calculations.
StatLink 2 https://stat.link/0wd3iv If the simulation is undertaken with backward-looking (adaptive) rather than forward-looking expectations for companies, households and financial markets, there are more noticeable differences. The first-year effect on inflation is similar, but thereafter the impact is weaker in the OECD economies. A key factor behind this is the larger negative effects on output, with GDP growth in the OECD economies declining by around 0.6 percentage points per annum on average in the first two years. This stems from a larger hit to investment and reduction in energy use, with firms and consumers unaware that higher energy prices will ultimately not persist.
Food and non-alcoholic beverages Housing, water, electricity, gas and other fuels Transport
C. United Kingdom
Figure 1.25. A further short-term rise in energy prices would hit growth and add to inflation
Note: Non-OECD oil denotes non-OECD oil-exporting economies and Non-OECD others denotes all remaining non-OECD economies. Forward (adaptive) indicates that producers and consumers have forward-looking (backward-looking) expectations. Simulation of a 30% rise in global oil, gas and coal prices sustained for three years and fading thereafter.
Source: OECD calculations using the NiGEM macroeconomic model.
StatLink 2 https://stat.link/hr0kgo
Risk repricing could expose vulnerabilities in the corporate sector and emerging-market economies
Financial markets have been resilient but vulnerabilities are mounting
Financial conditions have generally remained very favourable in both advanced and emerging-market economies. Reflecting ample policy support and robust investor risk appetite, bond issuance by sovereigns, non-financial corporations and financial firms has been very strong in 2021, and spending on mergers and acquisitions has soared.9 Spreads for lower-grade corporate bonds are still low, corporate debt levels have continued to rise (Figure 1.26, Panel A), and asset valuations appear very stretched in some markets, especially housing (Figure 1.27). These developments raise vulnerabilities to abrupt risk repricing in financial markets. The uncertain outcomes from the financial distress being experienced by China’s largest property developer could also trigger swings in risk appetite and slow global growth.
In contrast to the global financial crisis (GFC), current vulnerabilities seem to be more concentrated in the corporate sector. With the exception of China, household debt has been relatively stable over the last decade (Figure 1.26, Panel B) and household balance sheets are currently stronger than they were in 2007 (IMF, 2021a). More broadly, the GFC experience has played a role in limiting the amount of risk-taking in the household sector.10 Global corporate debt, on the other hand, has grown rapidly since the GFC, even as global corporate credit quality was declining (OECD, 2021d).
9 US investment-grade (IG) corporate bond sales, in particular, are on track for a near-record year in 2021, possibly because companies have sought to lock in low-cost funding before a potential gradual reduction of Federal Reserve support.
10 In the United States, for instance, underwriting standards have been strengthened. There are also fewer mortgages with variable interest rate payments, and standards for cash-out re-financing are now more stringent (IMF, 2021a).
OECD Non-OECD oil Non-OECD other
Figure 1.26. Debt levels have swollen, especially for companies
Note: GFC refers to the level of debt as of 2010 Q4. Debt comprises loans and debt securities.
Source: BIS Total Credit database.
StatLink 2 https://stat.link/2qn0x4
Figure 1.27. Housing valuations are stretched in many countries
House price-to-rent ratio, latest quarter available, long-run average=100Source: OECD Analytical House Price database; and OECD calculations.
StatLink 2 https://stat.link/dhjpo0
Advanced economies Emerging
market economies
Euro area United States Japan China
0 20 40 60 80 100 120 140 160
2019 Q4 GFC 2021 Q1
A. Non-financial corporations
Advanced economies Emerging
market economies Euro area
United States Japan China
0 20 40 60 80 100 120 140 160
B. Households
0 25 50 75 100 125 150 175 200 225 250
NZL CAN SWE AUS NOR BEL DNK LUX GBR COL CHL FRA ISR NLD MEX SVK TUR HUN CZE IRL ESP USA AUT ISL LVA DEU CHE FIN RUS SVN KOR EST PRT POL ZAF
Last available figure Lowest ratio since 1980 Highest ratio since 1980
Stress in the corporate sector is currently contained, but could rise
The significant public support provided to many companies since the start of the pandemic, favourable credit conditions, and the global recovery, are still keeping corporate bankruptcies in check. In Europe, bankruptcies are well below their historical standards, especially in France and Germany, and a similar picture emerges in other advanced economies (Figure 1.28, Panel A). In the United States, the slowdown in corporate bankruptcies observed in 2020 has persisted through 2021. Even in sectors hit relatively hard, such as energy, consumer services, transportation or real estate, the fallout has been limited so far with a flow of bankruptcies close to pre-pandemic levels (Figure 1.28, Panel B). Major banks in the United States and Europe also posted record profits in the first half of this year, partly as a consequence of a reduction in loan loss provisions.11 Overall, the wave of bankruptcies feared at the start of the COVID-19 crisis has not yet materialised.