How We Missed the Recent Inflation Surge
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Bibliographic details
- Authors: Christoffer Koch, DIAA NOURELDIN
- Published: March 1, 2023
Overview
- Article: "How We Missed the Recent Inflation Surge" by Christoffer Koch and Diaa Noureldin, F&D Magazine, March 2023.
- Central question: Why did professional forecasters, including at the IMF, repeatedly underpredict the rapid rise and persistence of the recent global inflation wave?
- Focus: Errors in core inflation forecasts (inflation stripped of volatile food and energy effects) published in the IMF's World Economic Outlook between Q1 2021 and Q2 2022.
- Key framing: Core inflation is "a slow-moving object" closely tied to central bank targets; large forecast errors point to misassessments of current and near-term demand and supply.
Ex post and ex ante analysis
- Two complementary approaches were used:
- Ex post: What do we know now with hindsight?
- Ex ante: What information was available at the time that was not sufficiently integrated into forecasts?
Underprediction factors (postmortem findings)
- Stronger-than-expected demand recovery:
- "Almost 80 percent of world GDP" is now known to have had smaller output gaps than projected in early 2021, indicating demand recovery exceeded expectations.
- Countries with faster-than-expected recoveries (examples: New Zealand, Singapore, Türkiye) experienced higher-than-expected inflation.
- This pattern was more prevalent in 2021 than in 2022, suggesting a role for demand overstimulation early in the recovery.
- Supply chain strain amplified by demand:
- Supply chain bottlenecks reflected an unusual combination of rising demand for goods and temporarily reduced supply during lockdowns.
- Forecast errors were larger, on average, in countries where demand pressures played a more prominent role in straining supply chains (examples: Brazil, New Zealand; to a lesser extent Canada and the US).
- Sectoral shift from services to goods:
- Early lockdowns caused a shift of demand from services to goods as leisure and hospitality largely ceased functioning.
- This reversed a previous trend of goods inflation being lower than services inflation.
- Economies with sharper reversals—where goods inflation was more elevated than services inflation—experienced larger forecast errors (examples: Brazil, Chile, US).
- Specific note: "core goods inflation in 2021 was more than twice that of services" in some economies referenced.
- Labor market tightness:
- Measured by the ratio of vacancies to unemployment, labor markets were particularly tight in Australia, Canada, the UK, and the US.
- This labor-market tightness significantly correlated with the magnitude of those countries' core inflation forecast errors.
- Aggregate interpretation:
- The combination of unexpectedly strong demand recovery, clogged supply chains, sectoral demand shifts, and heated labor markets offers a convincing retrospective explanation for repeated underpredictions of inflation.
Fiscal stimulus and forecasters' information set
- Fiscal packages announced in 2020:
- The aggressive fiscal stimulus in 2020 (described by some observers as resembling wartime spending) was part of the information set available to forecasters at the time.
- Analysis shows a positive correlation between the size of COVID-19 fiscal stimulus packages announced in 2020 and core inflation forecast errors in advanced economies in 2021.
- Nuances and caveats:
- The positive correlation is driven primarily by Australia, Canada, the UK, and the US—the same economies with pronounced labor-market tightness.
- Deeper analysis points toward misjudging the severity of supply constraints (including labor market constraints) as a larger contributor to forecast errors than underestimating the direct impact of fiscal policy on activity.
Policy trade-offs and implications for forecasting
- Trade-off in 2020:
- Too little fiscal stimulus risked prolonged scarring; too much risked overstimulation and sparking inflation.
- Given inflation was too low in advanced economies at the time, the inflation risk may have been underweighted relative to scarring concerns.
- Forecasting under uncertainty:
- Forecasters faced changed dynamics in goods and labor markets and difficult-to-parse real-time data.
- Evidence suggests large fiscal stimulus in a setting of supply constraints should have shifted inflation risks to the upside—though this inference hinges on outcomes in a few large economies.
- Recommendation for future forecasting and policy advice:
- The inflation outlook should better integrate the impact of fiscal policy, especially when supply constraints amplify excess-demand effects on inflation.
- Policymakers could have been advised to "reduce their speed somewhat back in 2020" given the inflation risks, but any assessment must be compared with the counterfactual of deep scarring to judge policy adequacy.
Country examples highlighted
- Faster recoveries with higher-than-expected inflation: New Zealand, Singapore, Türkiye.
- Supply-strain driven forecast errors: Brazil, New Zealand, Canada, US.
- Sectoral shift impacts: Brazil, Chile, US (noted that core goods inflation in 2021 was more than twice that of services in some cases).
- Labor-market tightness correlated with errors: Australia, Canada, UK, US.
Christoffer Koch is an economist in the IMF’s Research Department. Diaa Noureldin is a senior economist in the IMF’s Research Department.
Source: IMF F&D Magazine, March 2023 — "How We Missed the Recent Inflation Surge" by Christoffer Koch and Diaa Noureldin.
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- F&D March 2023: How we missed the recent Inflation surge