“Measuring European Trend Inflation with Tensor Factor Models” by Giovanni Ferretti

Topic

After a prolonged period of low inflation, European prices increased sharply from late 2021. The main drivers were strong post-pandemic demand supported by accumulated savings, global supply chain disruptions during the reopening phase, and the energy shock caused by the war in Ukraine, which also affected households’ inflation expectations. These developments raise concerns about the reliability of traditional core inflation measures that exclude volatile components such as energy and food.

To address this issue, we estimate European trend inflation using a tensor factor model applied to highly seasonal month-on-month inflation rates across sectors and countries. The model extracts a common underlying signal shared across time, sectors, and countries, while filtering out temporary and idiosyncratic fluctuations. Despite its parsimonious structure and limited number of parameters, the approach effectively captures the main dynamics of European inflation and provides a transparent and reliable tool for monetary policy analysis.