Inflation surges can be caused by many things, but one of the most common causes is when consumers have resilient interest for a service or good. When firms can’t keep up with that demand, they start raising prices to bring the supply back into line with the demand. This can lead to a chain reaction of price increases that eventually leads to a consumer-price index (CPI) peak. This type of inflation is called demand-pull inflation.
But if we look at the CPI data, most of the surge in inflation in 2021 and 2022 seems to have been due to supply-driven causes such as volatility in oil prices, backlogs of work orders for goods and services created by kinks in the supply chains during the pandemic, and sectoral price spikes like those that hit the auto industry. The surge in inflation also appears to have been driven by the various stimulus packages that temporarily increased consumer spending power and led them to spend more on goods with limited supplies.
Most forecasters expected that the rise in inflation from these factors would show up primarily in the labor market as higher wage pressures would push up prices for workers’ wages. But the inflation surge that we saw surprised many of us and also questioned the performance of our models and tools. In this Economic Brief, Felipe Schwartzman examines how we might better understand these unexpected developments.