Many people are finding their paychecks don’t stretch quite as far as they used to. This is partly because year-over-year prices are rising quickly. The inflation surge has surprised central banks, external experts, and markets. It is also raising questions about the ability of standard inflation predictors to detect and explain such events.
What’s causing this surge? Experts disagree about the exact cause, but most agree that a sudden change in world circumstances played a key role. The COVID-19 pandemic disrupted supply chains, creating shortages of some items and triggering prices to rise sharply. Meanwhile, fiscal stimulus packages temporarily increased household spending, driving up demand and adding to price pressures.
Some prices, such as traded commodities and wages established by contracts, rise every day. Others, such as the prices of goods and services purchased by households, are more “sticky,” taking longer to respond to changes in market conditions or to adjust to changing economic expectations. Unevenly rising prices reduce the purchasing power of consumers and increase the risk of deflation.
In our paper, we use new microdata to examine the dynamics of these two processes, including their interaction, in the context of the recent inflation surge. We find that the majority of the surge in year-over-year inflation is driven by developments that directly raise prices, rather than wages. This is evident from our decomposition of inflation shocks, which show that the initial jump in inflation was mainly due to global supply chain disruptions and surging oil and gas prices.