Inflation can harm people trying to save their money or borrow money. It erodes the purchasing power of saved cash, and it makes loans less valuable over time. Inflation can also slow economic growth and lead to stagflation, when unemployment rises and business investment stalls because workers aren’t spending their paychecks.
As Americans emerged from the COVID-19 pandemic lockdowns with spare cash and a willingness to spend, inflation became a major concern for investors, policymakers, and consumers. Yet it isn’t easy to understand what caused the sudden burst of price pressures. Some people pointed to supply chain kinks that created shortages of important goods; others blamed the various stimulus packages that gave many citizens more spending power, leading them to overspend and drive demand for goods up.
The answer may lie in a combination of these factors and in a more complex set of trade-offs between firms, central banks, and governments. Firms wanted to make profits and increase their market power, central banks feared hindering an economy that was already struggling, and governments wanted to help citizens while keeping unemployment low and avoiding costly austerity.
To gain a better understanding of the drivers, researchers developed models that decomposed price shocks into components that explain why inflation accelerated in some countries but not others. Their analysis suggests that global demand shocks and oil price shocks played an increasingly significant role in inflation during 2001-22, while the importance of global supply shocks diminished. In addition, the research reveals that the size of the unemployment gap, or the difference between current unemployment rates and pre-pandemic OECD forecasts for the natural rate of unemployment, accounts for a large part of cross-country variation in inflation acceleration.