The Global Dimension of Inflation: Exposing The Achilles' Heel of Stabilization Policy

Summary

The post-pandemic period was marked by global forces that raised inflation across all developed economies. Dominant explanations of inflation should be of a similarly global character. Policy discussions that reckon with counterfactuals and explainable magnitudes must go beyond nation-specific policies and dynamics. While local policies always shape inflation outcomes at the margin - and attract the most media commentary - the strongest explanations relate to global supply and demand forces rooted in pandemic and geopolitical shocks. The general absence of stabilization policies to manage global inflation shocks represents a serious vulnerability. Employ America has led the effort to think about how public authorities and assets, like the Strategic Petroleum Reserve, can help to stabilize global commodity prices. As we noted recently, there is still so much more work to do in this space to develop good policy. 

Discussion

Employ America was founded in 2019 to focus on how macroeconomic stabilization policy could drive strong labor market outcomes and the sustainable achievement of full employment. We have long been aware that change is the only constant in macroeconomics.. Underlying economic forces, institutional frictions, and political developments will shift over time, and the requisite policy prescriptions must adapt to ensure full employment is achieved. It's safe to say that the world of 2024 is not the world of 2019.

In the past 4 years, we've seen a historic bout of inflation. At a moment when there is eagerness to finger-point to specific policies, it's worth starting from a very simple fact: inflation was global.

Inflation was much higher across advanced economies from 2021 through 2024 than in the several years that preceded the pandemic. The effects of the pandemic, global supply chains, and global commodity markets all had proportionally global implications.

There was not much differentiation among the advanced economies' inflation profiles. You can try to rank the inflation profiles to determine who did better and who did worse, but the differentiation is small compared to the broader phenomenon. Unlike 2014-15, when Japan's VAT hike idiosyncratically pushed up its inflation rate, or 2010-13 & 2015-16, when Norway's currency caused outlier dynamics, the relative performance within the past 4 years is not as noteworthy as the outright performance.

Despite every country’s own idiosyncrasies in collecting price data and calculating inflation, inflation trajectories look remarkably similar. We did our best in the chart above to gauge inflation rates on a consistent methodology using the Harmonized Index of Consumer Prices (HICP) wherever available. However, it is not comprehensively available, nor does it follow a perfectly consistent methodology at the component-level wherever it is available. Even small methodological choices and shifts (e.g. whether to include administered prices, whether and how to account for changes in quality), can smudge the relative performance of post-pandemic inflation.

The most distinct US-specific fact is that it was among the earliest countries to start seeing elevated inflation and sustained disinflation. The US was relatively early in opening up the economy from the pandemic, both in terms of lifting lockdown measures and mass vaccination availability.

The US also returned to pre-pandemic HICP inflation rates faster than its peers and is currently a relative underperformer. Suppose  US-specific policies, like its relative fiscal ambition, are explanations for the burst of inflation. Are they also explanations for why the US now faces lower rates of inflation and faster rates of productivity growth relative to its peers? As tempting as it might be to fixate on domestic policies that are inflationary at the margin, robust parsimonious explanations should explain a range of important facts well. Not just a snapshot of a single time series.

We are left with a simple, cautious inference: country-specific dynamics and policies were unlikely to be the predominant driver of post-pandemic inflation. No two governments are alike. The pandemic and the subsequent recovery from it took place under a variety of different governments that pursued different approaches to policy. Some countries were more vulnerable to certain kinds of supply shocks (e.g. automobiles in the United States, natural gas in Europe). The fact that the outcomes were nevertheless more similar than different is telling. Global inflation primarily stems from global causes, and nation-specific causes are more peripheral in their explanatory power.

The component-level data suggests multiple channels through which inflation took on a global character:

1. The pandemic led to a shift in demand and away from services, only to sharply unwind during the reopening process.
2. Pandemic-induced demand volatility and frictions also spawned supply chain outages and bottlenecks independent of pandemic-related demand effects.
3. Russia's prominent role as a commodity producer led to a host of commodity prices spiking when its invasion of Ukraine triggered widespread sanctions and supply risks.

Global Pandemic Demand-Side Effects

The pandemic was a historically unique event that caused a series of unforeseen economic consequences downstream, but not all of them were about "supply." The pandemic and reopening processes had a series of demand-side idiosyncrasies:

1. Demand for in-person services collapsed only to subsequently revive and go through a "revenge" spending boom in subsequent years.
2. Demand shifted from services to goods in 2020 and 2021.
3. Expansionary fiscal policy was leveraged across all advanced economies, even as the scale and method of expansion substantially varied.

The pandemic initially drove a collapse in demand for services, particularly those that were in-person. Policy measures to contain and control the pandemic were taken to varying degrees across states and countries. Even after some of those measures lapsed, nominal and real spending levels were still far from what transpired pre-pandemic. Full recovery required a normalization of risk preferences from the pandemic, one that largely transpired as vaccines became more readily available.

The pattern in US in-person discretionary services inflation makes this clear. We saw a sudden drop-off in 2020, only to see subsequent pricing power in late 2021 and through much of 2022 and 2023.

There was clearly a demand-side component to this dynamic, as consumer spending for these services first fell precipitously, only to subsequently see "revenge demand" in subsequent years.

These patterns are not perfectly similar across countries. Some places merely saw lower inflation in the pandemic, but not the kind of outright deflation visible in the US. Yet for virtually all advanced economies, there was a burst of demand in the recovery period that was not matched with corresponding supply growth, and hence there was visible inflation across in-person services sectors (it's also fair to say that many of these sectors were not insulated from adverse supply shocks).

For the US, much of the growth started as a recovery from depressed prices in 2020 (and was likely inevitable and partially healthy) but soon swelled into a substantial rise in prices relative to pre-pandemic trend. While official US inflation measures of housing tend to lag and elongate what is already happening to market rents, the pattern fits a story of prices aggressively adjusting in 2021 as a result of the sharp demand and labor market recovery (more jobs & higher wages -> higher rental demand).

It should be noted that global comparisons of housing inflation are likely the most difficult due to methodological differences. Other countries' housing markets are also different from US markets in terms of price variability (housing costs are highly administered in some countries).

While there is certainly a role for the fiscal packages that virtually every advanced economy utilized over the pandemic, it's the universal components of these fiscal packages that have to be accounted for. Individual variation (e.g. furloughs vs unemployment insurance, the US' relatively ambitious fiscal expansion) does not have the explanatory power one might intuitively expect, even if we all agree there are effects at the margin.

Global Supply Chain Effects

Pandemic-related shortages swelled throughout 2021. Global auto supply chains were dependent on specific microchips (made primarily in Taiwan) for assembling final production. Major automakers had not realized that their ability to scale future production would be impaired by a global shortage for chipmaking capacity. With capacity to produce microchips for the automobile sector constrained, motor vehicle assemblies fell. We went through a two-year period of depressed output in the United States, and the output situation was similar elsewhere around the rest of the world.

The impact of this bottleneck was felt in goods, like new cars, used cars, and auto parts, but it also affected a range of service prices. With higher costs for parts and vehicles, the cost of maintenance, leasing, rental, repair, and insurance also went up with a lag.

This pattern was visible in the Eurozone too. Whereas US prices spiked sooner and the peak inflation rate for cars was higher, European prices accelerated later but sustained over a longer period of time.

A quick look at the state of supply chains in 2021 and 2022 will show that sources of bottlenecks reveal how a variety of other goods also faced similar supply-side challenges. China's COVID-Zero and Olympic Blue policies came with unique frictions for globalized China-centric supply chains, but pandemic outbreaks also led to production delays across other economies critical to supply chains. The 2021 and 2022 ISM reports make clear that bottlenecks ranged across manufactured products and transportation services.

To be clear, the sharp rise in demand that came with a recovering economy in 2021 and 2022 likely also enabled goods price growth in goods categories. Inflationary pricing power is strongest when consumer spending growth is strongest. Global fiscal supports helped keep household balance sheets relatively flush and allowed spending growth for goods to remain stronger for longer as variants still impaired services spending in 2021.

Nevertheless, the timing of the inflation in 2021 in so many goods prices, and the subsequent disinflation in these categories, specifically as production normalized for key goods, suggests a strong supply side component. In the process of reacting to the pandemic and coordinating global production to meet volatile and recovering demand, the global economy absorbed a series of adverse supply shocks along the way.

Global Commodity Market Effects

Commodity prices are perhaps the most salient for how ordinary consumers feel rising costs. Food and energy prices are often excluded from "core" inflation gauges that monetary policymakers use to forecast future inflation, but that does not make them any less essential.

In early 2021, it was clear that oil prices were poised to rise from their low 2020 price levels thanks to OPEC price cuts and recovering demand from the pandemic.

While the initial move from record-low oil prices in 2020 back to more normal $50-80/barrel price levels in late 2021 was to be expected, oil prices subsequently spiked further. Prices reached levels not seen since the summer of 2008 as a result of Russia's invasion of Ukraine. Russia, a major producer of crude oil for the world, was hit with widespread sanctions and markets understandably priced in the risk that Russian production might suddenly nosedive. But even as oil prices did not surpass their 2008 highs, gasoline prices did.

The loss of available Russian refining capacity alongside US refinery closures in 2020 meant that the price of refined products (gasoline, diesel, jet fuel, fuel oil) surged even further than the benchmark price for crude oil around the world. It's no wonder that the US saw its strongest bout of energy products inflation in several decades, as did the rest of the world.

As much as some commentators like to dismiss the Russian economy as a "gas station" of little global relevance, the prominent role it plays as a commodity producer goes beyond oil and gasoline. Its role can be seen across all refined petroleum products, natural gas agricultural commodities like wheat, fertilizer inputs like potash, and a range of key metals. And while minor commodity price changes tend to have more negligible passthrough effects to final consumer goods and services, historic cost increases tend to be pushed through to consumers. Firms are only able to absorb a finite amount of cost increases through lower margins.

Airline fares are an illustrative example of how global commodity price dynamics have meaningful passhtrough effects. Especially in the United States, airline fares are substantially a function of jet fuel prices. Even as the US was descending into a financial crisis and recession throughout 2008, the summer 2008 surge in crude oil and jet fuel prices managed to push airfare inflation substantially.

In an environment of firm nominal income growth and pandemic recovery, it's not that surprising to see such a historically strong upside impulse to airfares.

The loss of the Russian gas supply in Europe, which had a direct effect on energy services inflation alongside numerous secondary passthrough effects, didn't just affect Europe. Because the US scaled up LNG export capacity to Europe (and Asia), US benchmark natural gas prices were "pulled up" to match higher natural gas prices on other continents. The temporary outage of the Freeport Terminal in June 2022 led to a sudden fall in US natural gas prices as domestic supply was temporarily "trapped" at a lower price. As the terminal opened back up, US prices were pulled back up.

The surge in natural gas prices in 2022 had a direct impact on utility gas service prices for US consumers.

The passthrough effects are more variable for electricity, but the 2022 shock to natural gas prices substantially account for the higher electricity prices that American consumers had to pay.

The accumulation of global energy price shocks had downstream effects for energy-intensive goods and services. Food manufacturing costs are highly related to the cost of both agricultural and energy commodity prices.

With Russia's prominent role as an exporter of both agricultural and energy commodities disrupted, food prices saw a historic increase. Food services prices also inflated in a manner that was substantially explained by the historic increase in food prices.

The global surge in commodity prices, and especially in the fallout of Russia's invasion of Ukraine, amplified what was already a highly inflationary environment tied to pandemic effects on demand and supply chains.

Expanding The Stabilization Policy Toolkit

That inflation proved to be global is not a reason to throw up our hands and assume a historic bout of inflation was and will always be inevitable. Interest rate policy is a blunt lever for addressing many of these dynamics (a major reason for central banks to look at core inflation instead of headline inflation). But that need not be the only game in town, though we would gladly admit that to a first approximation, it still is.

Insuring against global pandemics, supply chain vulnerabilities, and commodity price shocks can and should take many different forms. Some cases will require a more pro-active preventative approach to regulation. Others will need a policy toolkit capable of reacting to emergencies decisively and proportionally. In most cases, a mix of the two will be crucial. In all cases, macroeconomic policymakers will need to monitor the economic dynamics more granularly and continuously.

Our work on commodity prices and production dynamics represents one vein of work in this space. Building out the policy tools that leverage the Strategic Petroleum Reserve, both in selling and buying back oil, represents an example of how public policy can help promote greater price stability for volatile globally traded commodities. Our work on standing up a North American lithium market infrastructure reflects a similar but tailored approach to promoting commodity price stability. Each critical commodity will require its own textured analysis and tailored policy remedies if its prices are to be robustly stabilized over time. Ideally, these efforts to stabilize commodity markets and promote supply resilience are coordinated thoughtfully, as we have laid out in our proposal for a Strategic Resilience Reserve.

There are still other aspects of stabilizing global inflationary phenomena where we're still only scratching the surface. Only from textured, persistent, and careful observation will it be possible to identify scalable policy solutions. We hope you join us in that journey.