Inflation will only fall if unemployment is higher than structural unemployment and the interest rate is higher than the neutral rate

In the United States and the euro zone, headline and core inflation are significantly higher than the 2% inflation target. The central banks will have to get inflation (core inflation in the United States) back down towards the inflation target. Financial markets believe this will happen with very modest increases in both short- and long-term interest rates. But it is important to remember that for core inflation to fall (headline inflation may fall if energy prices fall): The unemployment rate must be higher than the structural unemployment rate; The interest rate must therefore be higher than the neutral interest rate (even if the re is doubt over the pertinence of the theory of the neutral rate). These two conditions point towards a far more restrictive monetary policy than is expected in both the United States and the euro zone. We estimate that the structural unemployment rate is 4.5% in the United States and 8.5% in the euro zone; and that the nominal neutral interest rate is 4.3% in the United States and 3.4% in the euro zone.