The Cause of the Pandemic-Era Inflation

- 2 minutes read - 371 words

We all have experienced the unprecedented high inflation in the past two years. Some may be curious why the inflation can suddenly reach as high as 9%, while the inflation was staying around 2%-3% range in the past 40 years.

The former Fed Chairman Ben Bernanke (now at Brookings Institution) and Olivier Blanchard at the Peterson Institute, in a recent article, made the following explanation:

  1. Both issues on the supply side (prices of things like food and gas going up) and the demand side (lots of jobs available and workers in short supply) contributed to high inflation. At first, supply side issues like high commodity prices and supply chain problems caused most of the inflation. But now, the tight labor market is starting to push inflation higher too.

  2. People’s expectations about future inflation didn’t change that much. This limited how much higher prices in some areas (like food and gas) spread toinf other prices. That’s why inflation from supply side issues was temporary.

  3. However, as supply side issues get better, the tight labor market will keep pushing inflation higher unless something changes. The research model simulations show that businesses need to lower the number of job openings or raise wages less in order to bring inflation down over time.

  4. Traditional economic theories about how wages and prices move together can still explain what happened. But this experience shows policymakers need to pay attention to both labor market conditions and goods market problems when trying to control inflation.

  5. Looking ahead, a lot depends on how easily workers find jobs that match their skills and where they live. The relationship between jobs and unemployed workers has changed. If this keeps improving, inflation may come down without too much rise in unemployment. But it’s still very uncertain.

In a nutshell, the inflation was initially caused by the supply side issues, i.e. commodity prices shocks and supply chain issues. These were the results of the global lockdown during the pandemic. However, the Russia invading Ukraine in 2022 also contributed significantly to the commodity prices shocks. The inflation was later driven more by the demand side issues, i.e. tight labor markets. In the future, the demand side issues will be the deciding factors for the inflation.