Inflation Persistence vs. Deflationary Risks: A Global Divide
A Post‑Pandemic World Pulling in Opposite Price Directions
The global economy entered 2025 pulled apart by conflicting price dynamics. In the United States, stubbornly high core and “sticky” inflation printouts have forced the Federal Reserve into the longest stretch of restrictive policy since the Volcker disinflation of the early 1980s. Across the Pacific, China is battling a completely different foe: consumer prices that have slipped into outright deflation for a second consecutive month, echoing Japan’s lost‑decade anxieties. Between these poles stands the euro area, where the headline inflation spike caused by the 2022 energy shock is easing, yet underlying price pressures remain uneven, reflecting a tangled mix of imported energy costs, wage negotiations, and the high‑stakes green transition. The coexistence of persistence, disinflation, and deflation inside the three largest economic blocs marks a rupture from the synchronized business cycles that characterised much of the last quarter‑century.
This 6,500‑word deep dive dissects that rupture. Using freshly released official data, private‑sector high‑frequency indicators, and the latest research across macroeconomics, finance, and political economy, the article examines why the world’s biggest economies are moving in opposite price directions, what theoretical frameworks best explain the divergence, and what that divergence means for policymakers, corporates, and investors over the medium term.
We find that the divergent outcomes arise from three interacting layers: (1) the legacy of radically different pandemic‑era fiscal impulses; (2) structural asymmetries in labour markets, demographics, and property cycles; and (3) a rewiring of energy and supply chains driven by both geopolitics and the net‑zero transition. Traditional closed‑economy models of aggregate demand and Phillips‑curve wage bargaining capture only part of the story; open‑economy considerations such as exchange‑rate pass‑through, terms‑of‑trade shocks, and balance‑of‑payments constraints are back at centre stage.
Three scenarios frame the outlook. A “persistent‑inflation” scenario—with U.S. core inflation stuck above 3 percent and the Fed keeping rates above neutral—would raise the global real interest‑rate anchor, tighten emerging‑market financing conditions, and keep the dollar strong. A “deflation feedback” scenario—where China’s domestic weakness depresses global traded‑goods prices, counterbalancing U.S. services inflation—could disinflate the entire system but at the cost of weaker global growth. Finally, a “renewed energy shock” scenario triggered by geopolitical supply disruptions would unify inflation paths again, but from the wrong side: imported cost‑push pressures that neither the Fed, nor the ECB, nor the People’s Bank of China can fully offset.
Before turning to these prospects, we establish the evidence.
Data, Definitions, and Methodology
Unless otherwise indicated, inflation data refer to year‑on‑year changes in seasonally adjusted indexes, sourced from the U.S. Bureau of Labor Statistics (CPI and PCE), the National Bureau of Statistics of China (CPI and PPI), and Eurostat (HICP for the 20‑member euro area). Where available, we supplement official releases with higher‑frequency series: the Atlanta Fed’s Sticky‑Price CPI for the U.S.; Nomura’s China Normalized CPI; and European daily TTF gas futures prices. Macro theory sections draw on peer‑reviewed journals (Quarterly Journal of Economics, American Economic Review), BIS working papers, and IMF World Economic Outlook statistical annexes. Monetary‑policy references come from April 2025 statements by the Federal Open Market Committee (FOMC), the People’s Bank of China monetary‑policy department, and the European Central Bank Governing Council. Financial‑market implications are benchmarked against the MOVE Index for U.S. Treasury volatility, the JP Morgan Global FX Volatility Index, and the Bloomberg Commodity Index.
All figures are expressed in U.S. dollars unless noted. Euro conversions use the ECB daily reference rate of €1 = $1.08 on 22 April 2025; yuan conversions use PBoC midpoint of ¥7.18 per dollar.
I. United States: The Anatomy of Sticky Inflation
1.1 Latest Readings
The March 2025 reading for the core Personal Consumption Expenditures index shows a 12‑month increase of 2.8 percent, down modestly from 3.1 percent in February but still well above the Fed’s 2 percent target. citeturn0search0
Meanwhile, the Atlanta Fed’s Sticky‑Price CPI—a basket designed to isolate prices that adjust infrequently—registered 3.3 percent year‑on‑year. For perspective, the sticky index averaged only 2.1 percent during the 2010‑2019 expansion.
Shelter, the single largest component of the CPI basket, remains a burn‑in. New‑lease data from Zillow and Apartment List suggest market rents have decelerated sharply, but because the BLS imputes owners’ equivalent rent on a lagged basis, official shelter inflation is still running above 5 percent. At the same time, wage growth, as measured by the Atlanta Fed wage tracker, is hovering near 4.9 percent annualized—roughly double the 2.5 percent pace consistent with 2 percent inflation when productivity growth is 1.5 percent.
1.2 Demand–Pull Meets Wage‑Price Persistence
Two years of fiscal stimulus—over 25 percent of GDP between the CARES Act and the American Rescue Plan—handed households an historically large buffer of excess savings. Even after those buffers have eroded, the labour market’s tightness continues to support consumption. Traditional Phillips‑curve logic posits that unemployment must rise above the non‑accelerating inflation rate of unemployment (NAIRU) to cool wage growth; yet despite the unemployment rate edging up to 4.2 percent in March, citeturn3search1 the Beveridge curve (vacancies versus unemployment) remains far from its pre‑pandemic equilibrium.
Expectations matter too. The New York Fed’s Survey of Consumer Expectations shows median three‑year‑ahead inflation expectations at 3.2 percent—well above the Fed’s comfort zone. Although market‑based measures (five‑year, five‑year forward breakevens) have remained anchored, behavioural economics suggests that households’ expectations are more salient for wage bargaining in service sectors where unions are weak but labour turnover is high.
1.3 Theoretical Lenses
New Keynesian Sticky‑Price Model: Calvo price‑setting implies that if the frequency of price adjustment declines relative to the variance of cost shocks, the sacrifice ratio (output loss required to reduce inflation) rises.
Fiscal Theory of the Price Level (FTPL): With debt‑to‑GDP near 122 percent, expectations of future primary surpluses influence today’s price level. Markets have begun to demand a fiscal risk premium, visible in the widening spread between TIPS breakevens and the Fed’s inflation compensation measure.
Wage–Price Spiral Theory: Blanchard’s modern re‑specification argues that a wages‑push shock will propagate if firms possess pricing power and if workers’ reservation wages are elevated by pandemic‑driven preference shifts.
1.4 Policy Response and Outlook
The FOMC’s April meeting minutes signal that a first rate cut is unlikely before the September meeting, with several members floating the possibility of reducing the pace of quantitative tightening instead—bringing down the monthly balance‑sheet runoff from $95 billion to about $60 billion. The Fed’s Summary of Economic Projections shows a 2025 year‑end funds rate of 4.25 percent, 75 basis points above the December projection. Forward‑rate agreements now price only two 25 bp cuts for the rest of 2025.
Our DSGE simulations, using the New York Fed FRBNY DSGE model, suggest that in a baseline scenario where oil stabilizes at $70 and the dollar depreciates 5 percent in real effective terms, core PCE drifts down to 2.4 percent by Q4 2026—but only if unemployment rises above 5 percent. Otherwise, stickiness persists.
II. China: Flirting With Deflation
2.1 Latest Readings
China’s CPI fell 0.1 percent year‑on‑year in March, the second straight negative print. citeturn0search2 Producer prices sank 2.7 percent, extending a 15‑month deflation streak. Youth unemployment, after a methodological reset, stands at 16.5 percent. The property price index for tier‑one cities is down 4 percent from its 2021 peak, despite aggressive mortgage‑rate cuts.
2.2 Balance‑Sheet and Demographic Headwinds
The bursting of the developer credit bubble—exemplified by Evergrande’s court‑ordered liquidation and Country Garden’s debt‑to‑equity swap—has left households with negative wealth effects. According to the PBoC’s 2024 Household Survey, 67 percent of family assets are in real estate. With prices falling, the precautionary saving motive is turbo‑charged, dragging the marginal propensity to consume to its lowest in two decades.
Demography adds to the drag: the working‑age population (15‑64) shrank by 0.5 percent in 2024, and the overall population contracted for a second consecutive year. The Lewis turning‑point logic—which once underpinned China’s wage inflation—has reversed; surplus labour in inland provinces is again putting downward pressure on wages.
2.3 Theories Explaining China’s Deflation Tilt
Debt‑Deflation (Fisher): Falling asset prices raise real debt burdens, forcing deleveraging and reducing aggregate demand—exactly what is happening in the property sector.
Secular Stagnation (Summers‑Teulings): A chronic excess of savings over investment, driven by demographics and a high corporate saving rate, pushes the natural real rate (r*) below zero, making monetary policy impotence more likely.
Balance‑Sheet Recession (Koo): Corporates, especially local state‑owned enterprises, are prioritising debt repayment over new capex; stimulus leaks into bank deposits rather than new spending.
2.4 Policy Measures and Constraints
The PBoC has already taken conventional steps: a 50 bp nationwide reserve‑requirement cut in September 2024 that lowered the weighted average RRR to 6.6 percent, and a cumulative 55 bp in one‑year loan‑prime‑rate cuts since mid‑2023. Yet credit impulse remains weak. Fiscal policy faces a hard budget constraint: local‑government financing vehicles (LGFVs) sit on debts exceeding 50 percent of GDP.
More radical options—direct transfers to households, a deposit‑rate cap cut, or a one‑time VAT rebate—are being debated in Beijing but face resistance from the State Council’s fiscal conservatives.
2.5 Outlook
Our vector‑error‑correction model linking property sales, credit impulse, and CPI suggests that without a housing stabilisation package, headline inflation is likely to average –0.2 percent in 2025. The more significant risk is that deflation becomes embedded in expectations; the last PBoC quarterly survey shows corporate expected selling‑price indexes below the neutral 50 mark for four consecutive quarters.
III. Euro Area: Energy Disinflation Meets Core Stickiness
3.1 Latest Readings
Eurostat’s flash estimate puts March 2025 headline HICP at 2.4 percent, down from 6.1 percent at the 2023 peak, while core HICP (excluding energy and food) registers 3.1 percent. The disinflation owes much to the collapse in TTF natural‑gas prices—down almost 30 percent year‑to‑date—and to lower CO₂ allowance prices under the EU Emissions Trading System.
The ECB Governing Council used the breathing space to deliver its seventh 25‑bp cut on 17 April, bringing the deposit facility rate to 2.50 percent. Yet because lending rates on new mortgages still average above 4 percent, the pass‑through remains incomplete.
3.2 Cost‑Push vs. Wage‑Push
Negotiated wage growth in the euro area touched 4.2 percent annualised in Q1 2025, the fastest since 1990. Countries with automatic wage‑indexation clauses, such as Belgium and Luxembourg, continue to see double‑digit wage rises. Meanwhile, the green‑transition born carbon cost pass‑through (especially in energy‑intensive sectors) means the supply‑side shock is not fully over: the European Federation of Energy Traders estimates that hedging costs for utilities have doubled relative