Strong Demand Drove Post-Pandemic Inflation Rise

Unexpectedly strong demand for goods and services drove post-pandemic inflation. This finding comes from a Brookings Papers on Economic Activity discussion scheduled for September 25.

Economists Domenico Giannone and Giorgio Primiceri analyzed price trends in the US and euro area. They conclude that demand strength outweighed supply disruptions in raising consumer prices.

Demand outpaced supply constraints

Inflation stayed low in 2020 as the pandemic hit both sides of the market. U.S. prices then accelerated in the first half of 2021 and peaked in the second quarter of 2022.

Euro area inflation followed the same path but arrived about six months later. The authors state that this synchronized movement across the Atlantic points to a common cause.

Three specific forces made demand unusually strong during this period. A rapid spending rebound, high government deficits, and low interest rates all fueled the surge in economic activity.

Policy choices shaped the recovery

Forecasters on both sides of the Atlantic underestimated how long inflation would last. They also missed the true strength of the economic recovery in their early models.

Monetary policy helped cushion the blow from supply chain problems. By keeping rates low, central banks supported the recovery but allowed additional inflation to build up.

Real-time data releases initially painted a more pessimistic picture of the economy. Policymakers may have simply been reacting to what the data showed at that time.

Credibility determines central bank power

Primiceri notes that ignoring temporary shocks relies on central bank credibility. This trust is built on a history of reacting strongly to contain price increases.