Current State of US Economy Post-Pandemic and the Future of Core Inflation

Abstract

The current state of the US economy is recognized with the highest debt level and a dramatic rise in the M2 Money Supply along with a decrease in the Velocity of Money. We target the exogenous nature of the recent negative output shock, and we employ a reduced form Vector Auto Regressive model to study the future of the Core Inflation. Our main findings confirm that a positive shock in the Velocity of Money, and M2 Money Supply (most significantly) will increase the Core Inflation beyond a transitory phase; while a positive shock in Unemployment Rate is associated with a negative response in Core Inflation. We find that initially after the shock, the Velocity of Money significantly explains the Core Inflation variability but moving forward in the horizon, the Supply of Money becomes the dominant indicator of the variability in the Core Inflation. We estimate the increase in the M2 Money Supple to drag up the annualized quarterly Core Inflation to more than 4 percent for the third quarter and to more than 3.7 percent for the fourth quarter of 2021.