Inflation sensitivity to economic pressure has quadrupled since 2020
US data shows a sharp break in the link between demand and prices. The response to economic tightness is now roughly four times higher than pre-2020 levels.
Inflation in the United States reacts significantly more to economic pressure than it did in the 2010s. A one-standard-deviation rise in economic tightness now drives an estimated 1.7 percentage point increase in inflation one year later. This figure is approximately four times the 0.4 percentage point response observed before 2020.
This shift challenges the assumption that economies can run hot with minimal inflationary cost. The Phillips curve has steepened, meaning additional demand passes into prices more readily. This dynamic complicates the task of central banks seeking to manage growth without triggering price spikes.
Historical shift in price sensitivity
The relationship between labor slack and inflation has changed over time. It was firm during the mid-2000s expansion and flattened after the global financial crisis. It steepened sharply after 2020. This pattern suggests the curve depends on the state of the economy.
Inflation responds weakly when capacity is abundant. It responds strongly when labor, energy, and supply chains are constrained. A sufficiently large downturn could flatten the curve again. This implies that the current sensitivity is conditional on economic conditions.
Evidence across major economies
Data from the United States, United Kingdom, Japan, and Canada shows a similar trend. Inflation has become more responsive to labor market tightness since 2020 in all four countries. This holds even when controlling for supply chain pressure and energy prices. The source GN markets/inflation (en-US) notes that supply disruption explains part of the change, but not all of it.
The post-2020 samples are short. The euro area cannot be included in this specific analysis. These estimates require caution due to limited data points. The broader implication is that demand-driven inflation is now more elastic.
Implications for central bank policy
US CPI inflation fell from 9.1 percent in June 2022 to around 3 percent by mid-2023. This decline occurred without a severe recession. A steeper relationship means demand-driven inflation can fall with only modest easing of economic pressure. However, supply-driven inflation remains difficult to eliminate without significant economic cost.
Policymakers must account for this higher sensitivity. The assumption that inflation is largely inert to demand shocks is no longer secure. The end of painless disinflation suggests that future price stability will require more active management of aggregate demand.
