Inflation’s Rise and Fall

Source details

Topic: Recent global inflation surge and subsequent decline.
Timeframe emphasized: inflation began rising in 2021; became acute by 2022; fall in headline inflation observed after widespread monetary tightening; sample ends in March 2024.
Core assertion: Recent price swings reflected largely energy- and supply-related shocks rather than macroeconomic overheating.

Sample: 21 advanced and emerging market economies.
Decomposition approach:
- Headline consumer price inflation = underlying (core) inflation + headline shocks (deviations of headline from core inflation).
- Core inflation explained by long-term inflation expectations and broad measures of macroeconomic slack (unemployment rate, output gap, ratio of vacancies to unemployment).
- Headline shocks explained by large price changes in particular industries (food, energy, shipping) and measures of supply-chain disruptions.
- Model allows for pass-through over time from industry price shocks to core inflation via effects on wages and production costs.

Primary drivers:
- Headline shocks and their pass-through into core inflation account for most of the rise and fall of inflation across the sample.
- Broader measures of macroeconomic slack and changes in longer-term inflation expectations generally contribute little.
Global vs local drivers:
- Inflation’s rise and fall reflected primarily global drivers (notably energy and food prices), but local circumstances mattered.
- Differences in local energy price policies, including subsidies, explain cross-country variation in the contribution of energy price shocks (example: France).
United States exception:
- The United States is a significant exception: the contribution of broad macroeconomic tightness to inflation remains greater than in other economies despite the significant cooling of the labor market since early 2023.
- The fall in US headline inflation since February 2023 reflects equally the cooling of the broader economy and the fading pass-through from earlier headline shocks.
- Since March 2024 (sample end), US labor market conditions have further moderated, which should help inflation return to target.
Inflation expectations and monetary policy:
- Long-term inflation expectations remained well anchored throughout the period.
- This suggests central bank credibility helped prevent wage-price spirals.
- Global tightening of monetary policy may also have helped bring down global demand and hence energy prices.

France:
- Large price-suppressing fiscal measures and a relatively small contribution of energy to headline inflation shocks.
Energy shocks:
- The surge in energy and food prices, intensified by Russia’s invasion of Ukraine, triggered an energy crisis akin to the 1970s oil shocks.
- Energy shocks and their pass-through, as well as their reversal, account for the bulk of the rise and fall of inflation, without the need for a deep economic slowdown.

Monetary policy:
- Maintaining credibility and anchoring long-term inflation expectations is key to preventing wage-price spirals.
- Rapid and synchronized monetary tightening contributed to the swift decline in inflation.
Fiscal and energy-price policies:
- Local energy price policies, including subsidies, materially affect how energy shocks transmit to headline inflation.
- Price-suppressing fiscal measures can reduce the contribution of energy shocks to headline inflation.
Monitoring pass-through:
- Policymakers should monitor the pass-through from headline shocks to core inflation (via wages and production costs) when assessing inflation persistence and appropriate policy responses.

Source: "Inflation’s Rise and Fall" — MAI CHI DAO, Prachi Mishra, DANIEL LEIGH; F&D Magazine; September 2024.

Inflation’s Rise and Fall
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