Inflation as a post-COVID syndrome

The structure and intensity of inflation in the United States in recent years is largely associated with sharp changes in the labor markets during the coronavirus pandemic, which also intensified the energy shock that began quite early. The paper, prepared by IMF economists, suggests that the US Federal Reserve’s inflation-unemployment targets are significantly lower, suggesting inflation that is adequate to current high US employment could be well above the Fed’s targets in the long term.

An article in a series of NBER publications by two economists from the International Monetary Fund (IMF) Daniel Ley and Prachi Mishra, as well as Lawrence Ball from Johns Hopkins University, is devoted to one of the most pressing problems for economists in the coming months – the nature and characteristics of the 2022 inflation surge in major economies , primarily in the USA. The analysis of Ley, Mishra and Ball differs from most studies on this subject in the horizon of the events under consideration: the authors do not dwell on stating that the inflationary surge in 2022 was caused by an increase in world energy prices due to sanctions against the Russian Federation (due to its military operation in Ukraine), but consider the current inflation as one of the episodes of the events of 2020–2022 — the covid pandemic and its economic consequences.

Lay, Mishra, and Ball decompose core inflation versus headline inflation, showing that inflation events in 2022 essentially have two components reflected in core inflation. The first is the translation into core inflation of spikes in energy prices in 2020, determined by disruptions in supplies, including energy, during the pandemic: in the midst of quarantines, this effect was largely blurred, in many respects the price peaks in 2022 are a consequence of the events of 2020– 2021, damped by the specific mechanisms of the global energy and financial markets. The second component is very unusual developments in the labor markets.

As applied to the US, much of the pro-inflationary effects of COVID-19 work restrictions appear to be realized in higher core inflation only in 2022.

Technically, the work of Ley, Mishra, and Ball is rather complicated; in particular, the authors return to the “Beveridge curve” rarely discussed in recent years in the literature, which describes the relationship between vacancies and unemployment rates in the economy. In general, for the first time, economists raise the question of the extent to which formal indicators of the labor market are related to the actual state of this market – lockdowns were very rude and mechanical short-term intervention in the market, and their reflection in such indicators as unemployment may be inadequate, since “pandemic” and “natural” unemployment have a different nature and can be related in different ways to indicators of GDP, industrial production, services and inflation.

Note that the explicitly proclaimed goal of the authors is to give theoretical assumptions about the future dynamics of inflation in the United States in the medium term. And here Lay, Mishra and Ball claim that the US Federal Reserve’s use of 2022 US unemployment data (an all-time low, close to “full employment” in terms of inertial effects in the labor market and other adjustments), of which inflation should normalize at 2% year on year with unemployment at 4.4%, should underestimate the time it will take for the main financial market of the world – the US – to normalize under this policy of the Fed. In fact, economists believe that in order for US inflation to return to 2% per annum, unemployment rates would have to be significantly higher – perhaps at the level of about 7.5%. Since this figure is hardly politically acceptable for the Fed with its “double mandate”, the correctness of Ley, Mishra and Ball will mean a long-term preservation in the United States and through it in the world, including in world energy prices, of an increased inflation background. As for the labor market itself, the authors’ appeal to the topic of the actual correlation between unemployment rates and the state of the labor market is promising (especially in light of the consequences of the COVID-19 pandemic), including for studying the impact of changes in post-pandemic employment on the price level — it is possible that that structural transformations in employment will determine relatively high prices while maintaining existing models by central banks for many years to come.

Dmitry Butrin