Post-pandemic inflation: Phillips curve, trends, drivers and lessons

Abstract

After several years of very low inflation, the world economy in 2021 and 2022 has been confronted with an abrupt and persistent rise in inflation rates not seen for decades. This paper investigates the main factors behind the surge in consumer price inflation in advanced economies and possible differences across them. It assesses the relative role of excess demand arising from the reopening of economies after the COVID-19 restrictive measures, global value chain and supply-side disruptions, higher energy prices, the “base effect”, and labour market pressures. We find that prices were initially pushed up by the fast world demand recovery combined with global supply disruptions, but eventually, especially since the war in Ukraine, energy prices have become the main driver of increased inflation. Differences in the contribution of the core inflation component across advanced economies, especially between the United States and the rest, reflect differences in output gaps and labour market tightness, while unit labour cost pressures remained muted almost everywhere. Given that inflation is expected to remain elevated for longer than initially anticipated, monetary authorities are expected to become more “conservative” again, defending their credibility. Past experience suggests that, as the economic slowdown becomes inevitable, the short-term costs of a gradual and orderly monetary policy normalisation to activity and employment are probably lower than the potential longer-term costs of a more popular prolonged accommodative policy. The anchoring of inflation expectations is not a free lunch.