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BPEA Conference Drafts, September 8-9, 2022Understanding U.S. Inflation During the COVID EraLaurence Ball, Johns Hopkins UniversityDaniel Leigh, International Monetary FundPrachi Mishra, International Monetary Fund每 日 免 费 获 取 报 告1、每日微信群内分享 7 +最新重磅报告；2、每日分享当日华尔街日报、金融时报；3、每周分享经济学人4、行研报告均为公开版，权利归原作者所有，起点财经仅分发做内部学习。扫一扫二维码关注公号回复：研究报告加入“起点财经” 微信群。 Conflict of Interest Disclosure: Daniel Leigh and Prachi Mishra are employees of the International Monetary Fund, which conducts a review of all externally published pieces. The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. The authors are not currently an officer, director, or board member of any organization with a financial or political interest in this article. Understanding U.S. Inflation During the COVID Era Laurence Ball, Daniel Leigh, and Prachi Mishra* Conference Draft, August 2022 This paper analyzes the dramatic rise in U.S. inflation since 2020, which we decompose into a rise in core inflation as measured by the weighted median inflation rate and deviations of headline inflation from core. We explain the rise in core with two factors, the tightening of the labor market as captured by the ratio of job vacancies to unemployment, and the pass-through into core from past shocks to headline inflation. The headline shocks themselves are explained by large increases in energy and automobile prices and by supply chain problems as captured by backlogs of orders for goods and services. Looking forward, we simulate the future path of inflation for alternative paths of the unemployment rate, focusing on the projections of Federal Reserve policymakers in which unemployment rises only slightly to 4.1 percent. We find that this unemployment path returns inflation to near the Feds target only under optimistic assumptions about both inflation expectations and the Beveridge curve relating the unemployment and vacancy rates. Under less benign assumptions about these factors, the inflation rate remains well above target unless unemployment rises by more than the Fed projects. * Email: lballjhu.edu; dleighimf.org; pmishraimf.org. Ball is at Johns Hopkins University. Leigh and Mishra are at the Research Department of the IMF. We are grateful to Philip Barrett, Nigel Chalk, Jason Furman, Pierre-Olivier Gourinchas, N. Gregory Mankiw, Aysegul Sahin, Antonio Spilimbergo, and James Stock for comments on an earlier draft. We thank Regis Barnichon for providing us with data; Mattia Coppo, Yiyang Han, Nino Kodua, and Kyung Woong Koh for excellent research support; and Eduard Laurito and Gabi Ionescu for administrative support. All errors remaining are our own. The views expressed here are those of the authors and do not necessarily represent those of the IMF, its Management and Executive Board, or IMF policy. 1 After four decades of low U.S. inflation, high inflation has emerged as a central economic problem of the COVID era. As of July 2022, the rate of CPI inflation over the previous 12 months was 8.5 percent. This experience has produced an outpouring of analyses of why inflation has risen and where it might be heading in the future. This paper seeks to contribute to this debate. A central feature of our analysis is that we decompose the headline inflation rate into two components that are determined by different factors: core inflation, and deviations of headline from core. We seek to explain core inflation with long-term expected inflation and the level of slack or tightness in the labor market, and to explain the non-core component of headline inflation with large price changes in particular industries. We also study the pass-through over time from these industry price shocks to core inflation, which can occur through the effects of headline inflation on wages and other costs of production. Section 1 of this paper describes how we measure core inflation. Our primary measure is the weighted median inflation rate published by the Federal Reserve of Cleveland, which strips out the effects of unusually large price changes in certain industries. This variable isolates the core component of inflation more effectively than the traditional core measure of inflation excluding food and energy prices, especially during the COVID era, when much volatility in headline inflation has come from price changes in industries other than food and energy. In July 2022, weighted median inflation accounted for 6.3 percentage points of the 8.5 headline inflation rate. Section 2 studies the behavior of core inflation. A key feature of the analysis is that, following recent studies such as Furman and Powell (2021) and Barnichon, Oliveira, and Shapiro (2021), we measure the tightness of the labor market with the ratio of job vacancies (V) to unemployment (U). We find that the very high levels of V/U over 2021-2022 can explain much of the rise in monthly core inflation, especially during 2022. The rest of the rise is explained by a substantial pass-through of headline-inflation shocks into core inflation. These results help us understand why persistently high inflation has been a surprise to the many economistsincluding us (Ball and others, 2021a)who dismissed the run-up in inflation in mid-2021 as transitory. These economists typically measured labor market tightness with the unemployment rate, which has so far only fallen to but not below pre-pandemic levels, and they ignored the pass-through effect that can propagate the effects of headline-inflation shocks. Section 3 studies the pandemic-era shocks to headline inflationthe deviations of headline from corethat have contributed to inflation both directly and through the pass-through to core. 2 We find that three factors have been most important in explaining this component of inflation: changes in energy prices; changes in prices in auto-related industries; and a measure of backlogs of goods and services orders from the information services firm IHS Markit Economics, which we believe captures the widely-reported problems with supply chains. Section 3 also performs a decomposition of the 7.2 percentage point rise in headline inflation between end-2020 and July 2022 (from 1.3 percent to 8.5 percent). It concludes that the combination of direct and pass-through effects from headline-inflation shocks accounts for about 5.5 percentage points of the rise in 12-month inflation. A rise in expected inflation accounts for 0.5 percentage point, and the rise in labor market tightness (measured by the ratio of vacancies to unemployment) accounts for 1.0 percentage point. After analyzing the inflation experience to date, we turn to what might happen in the future. We focus on the question of what costs must be incurred for the Federal Reserve to meet its goal of reining in inflation. Fed officials have predicted a soft landing in which inflation returns to their target with only a small increase in unemployment, while pessimists such as Summers (2022b) believe that disinflation will require a painful recession with high unemployment. Which outcome is more likely? In our view, the answer depends largely on two factors, which we discuss in Section 4. One is the relationship between unemployment and vacanciesthe Beveridge curve. This relationship has shifted unfavorably during the pandemic: a given level of vacancies implies a higher level of unemployment. The unemployment costs of reducing inflation will be substantial if this relationship now remains unchanged, but the costs will be lower if a normalization of the labor market moves the Beveridge curve back toward its pre-pandemic position. The second factor concerns long-term inflation expectations. By various measures, these expectations have been well-anchored through most of the pandemic period, but they have shown hints of increasing during 2022. The costs of containing inflation will be greater if these hints turn into a significant upward trend in expected inflation. It is difficult to predict how expectations will evolve, but we try to shed light on the possibilities by estimating the response of survey measures of expectations to movements in actual inflation. Section 5 presents simulations of future inflation under alternative assumptions about these issues and about the path that the unemployment rate will follow. One unemployment path that we consider is the one forecast by Fed policymakers in their June 2022 Summary of Economic 3 Projections (SEP), which peaks at 4.1 percent in 2024. In this case, if we make quite optimistic assumptions about both the Beveridge curve and inflation expectations, the inflation rate falls to a level near the Feds target by the end of 2024. For a range of other assumptions, however, inflation stays well above the target. All in all, it seems likely that policymakers will need to push unemployment higher than these SEP projections if they are determined to meet their inflation goal. Research over the last two years has yielded many insights into the factors behind inflation, and we borrow a number of these ideas, as we discuss throughout the paper. We seek to synthesize much of the recent thinking about inflation in a way that allows a transparent analysis of the data, a quantification of the impact of different factors, and an informed analysis of where inflation may head in the future. 1. HEADLINE AND CORE INFLATION Our framework for studying inflation is based on a common decomposition: (1) headline inflation = core inflation + headline shocks . Core inflation is also known as underlying inflation. We interpret this variable as a relatively slow-moving component of inflation that depends on inflation expectations and slack in the aggregate labor market, as in the textbook Phillips curve. Headline shocksthe deviations from coreare high-frequency movements arising from large price changes in particular sectors of the economy. Fluctuations in energy prices are a perennial source of headline shocks. During the pandemic, large price changes have also occurred in industries affected by shutdowns and supply disruptions, such as travel-related industries and used cars. Here we describe how we measure core inflation and then examine the paths of headline and core inflation since 2020. A. Measuring Core Inflation The traditional measure of core inflation, the one that the Federal Reserve focuses on, is the inflation rate excluding food and energy prices (XFE inflation). This measure is so common that some economists use the term “core inflation” as a synonym for XFE inflation. However, a growing body of research argues that XFE inflation is a flawed measure of the economic concept 4 of core. The XFE measure was developed in the 1970s, when changes in food and energy prices caused large fluctuations in headline inflation (Gordon, 1975). Since that time, volatility in headline has also arisen from large price swings in industries besides food and energy, which are not filtered out of XFE inflation, and this phenomenon has been especially pronounced during the pandemic (Dolmas, 2005; Ball and others, 2021b). The shortcomings of the XFE core measure have led researchers to develop a class of alternatives: “outlier exclusion” measures that systematically filter out large price changes in any industry. These measures are weighted medians or trimmed means of the distribution of industry price changes. A number of studies find that these core measures are less volatile and more closely related to economic slack than XFE inflation (for example, Dolmas and Koenig, 2019; Verbrugge, 2021; and Ball and others, 2021b).1 This paper focuses on one specific outlier-exclusion measure of core, the weighted median CPI inflation rate published by the Federal Reserve Bank of Cleveland. It is the oldest such measure, published since the 1990s, and arguably the simplest. The Appendix to this paper considers other outlier-exclusion core measures, such as the trimmed mean PCE deflator inflation rate published by the Federal Reserve Bank of Dallas, and the weighted median PCE deflator published by the Federal Reserve Bank of Cleveland. With core inflation measured by weighted median inflation, we define “headline-inflation shocks” as deviations of headline from median. By construction, our measures of core inflation and headline shocks sum to headline inflation. Bryan and Cecchetti (1994) discuss the rationale for outlier-exclusion measures of core. In their framework, a large change in a sectors relative price affects the aggregate price level because, with costs of nominal price adjustment, large shocks to optimal prices have disproportionately large effects on actual price changes. Removing outliers from the price distribution filters out the effects of relative price changes, thereby isolating the part of inflation determined by macroeconomic forces. See Ball and Mazumder (2011) for more on these ideas. The theory of core inflation has not been perfected, and more research is warranted. That said, in judging core inflation measures for present purposes, we believe that the proof of the pudding is in the eating. Throughout this paper, we find that our decomposition of headline inflation into 1 Similar evidence led the Bank of Canada to adopt a weighted median and trimmed mean as official measures of core inflation in 2016, replacing its CPIX measure, which is similar to XFE. 5 median and deviations from median is a fruitful framework for understanding COVID-era inflation. We also show that much of our analysis would be infeasible if we measured core with XFE inflation.2 B. Headline and Core Inflation Since 2020 We focus here on inflation in the consumer price index (CPI); the Appendix considers the personal consumption expenditure (PCE) deflator. Figure 1 shows the paths of headline and median CPI inflation from January 2020 through July 2022 (the latest data available as this paper is written). The graph on the left shows monthly inflation at seasonally adjusted annualized rates, and the graph on the right shows inflation over the past 12 months, a statistic that is widely reported in the media. We can see from the Figure that monthly headline inflation has been highly volatile, plunging close to -10 percent in April 2020, fluctuating up and down for the rest of that year, and coming in at 10 percent or higher at a number of points in 2021 and 2022. Monthly headline inflation soared to 17.1 percent in June 2022 and then fell to -0.2 percent in July. The preponderance of high monthly readings since early 2021 pushed 12-month headline inflation up steadily to a peak (so far) of 9.1 percent in June 2022, and it was 8.5 percent in July. Median inflation has been much less volatile, with the monthly series never changing by more than 3 percentage points from one month to the next. Median inflation drifted down in the first part of the pandemic, and as late as September 2021 the 12-month median was stil
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