Category: Macroeconomics

Solved Problem: How Can Total Employment and the Unemployment Rate Both Increase?

Photo from the New York Times.

Supports: Macroeconomics, Chapter 9, Section 9.1, Economics Chapter 19, Section 19.1, and Essentials of Economics, Chapter 13, Section 13.1.

As it does on the first Friday of each month, on September 2, 2022, the U.S. Bureau of Labor Statistics (BLS) released its “Employment Situation” report for August 2022. According to the household survey data in the report, total employment in the U.S. economy increased in August by 442,000 compared with July. The unemployment rate rose from 3.5 percent in July to 3.7 percent in August. According to the establishment survey, the total number of workers on payrolls increased in August by 315,000 compared with July.

  1. How are the data in the household survey collected? How are the data in the establishment survey collected?
  2. Why are the estimated increases in employment from July to August 2022 in the two surveys different? 
  3. Briefly explain how it is possible for the household survey to report in a given month that both total employment and the unemployment rate increased.

Solving the Problem

Step 1: Review the chapter material. This problem is about how the BLS reports data on employment and unemployment, so you may want to review Chapter 9, Section 9.1, “Measuring the Unemployment Rate, the Labor Force Participation Rate, and the Employment–Population Ratio.” 

Step 2: Answer part a. by explaining how the data from the two surveys are collected. As discussed in Section 9.1, the data in the household survey is from interviews with a sample of 60,000 households, chosen to represent the U.S. population. The data in the establishment survey—sometimes called the payroll survey in media stories—is from a sample of 300,000 establishments (factories, stores, and offices).  

Step 3: Answer part b. by explaining why the estimated increase in employment is different in the two surveys.  First note that the BLS intends the surveys to estimate two different measures of employment. The household survey includes people working at jobs of all types, including people who are self-employed or who are unpaid family workers, whereas the establishment survey includes only people who appear on a non-agricultural firm’s payroll, so the self-employed, farm workers, and unpaid family workers aren’t counted. Second, the data are collected from surveys and so—like all estimates that rely on surveys—will have some measurement error.  That is, the actual increase in employment—either total employment in the household survey or payroll employment in the establishment survey—is likely to be larger or smaller than the reported estimates. The estimates in the establishment survey are revised in later months as the BLS receives additional data on payroll employment. In contrast, the estimates in household survey are ordinarily not revised because they are based only on a survey conducted once per month.  

Step 4: Answer part c. by explaining how in a given month the household survey may report an increase in both employment and the unemployment rate.  The BLS’s estimate of the unemployment is calculated from responses to the household survey. (The establishment survey doesn’t report an estimate of the unemployment rate.) The unemployment rate equals the total number of people unemployed divided by the labor force, multiplied by 100. The labor force equals the sum of the employed and the unemployed. If the number of people employed increases—thereby increasing the denominator in the unemployment rate equation—while the number of people unemployed remains the same or falls, as a matter of arithmetic the unemployment rate will have to fall. 

The BLS reported that the unemployment rate in August 2022 rose even though total employment increased. That outcome is possible only if the number of people who are unemployed also increased, resulting in a proportionally larger increase in the numerator in the unemployment equation relative to the denominator. In fact, the BLS estimated that the number of people unemployed increased by 344,000 from July to August 2022. Employment and unemployment both increasing during a month happens fairly often during an economic expansion as some people who had been out of the labor force—and, therefore, not counted by the BLS as being unemployed—begin to search for work during the month but don’t find jobs.

Source: U.S. Bureau of Labor Statistics, “The Employment Situation—August 2022,” bls.gov, September 2, 2022.  

Why Might Good News for the Job Market Be Bad News for the Stock Market?

Photo from the New York Times.

On Tuesday, August 30, 2022, the U.S. Bureau of Labor Statistics (BLS) released its Job Openings and Labor Turnover Survey (JOLTS) report for July 2022. The report indicated that the U.S. labor market remained very strong, even though, according to the Bureau of Economic Analysis (BEA), real gross domestic product (GDP) had declined during the first half of 2022. (In this blog post, we discuss the possibility that during this period the real GDP data may have been a misleading indicator of the actual state of the economy.)

As the following figure shows, the rate of job openings remained very high, even in comparison with the strong labor market of 2019 and early 2020 before the Covid-19 pandemic began disrupting the U.S. economy. The BLS defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days. The rate of job openings is the number of job openings divided by the number of job openings plus the number of employed workers, multiplied by 100.

In the following figure, we compare the total number of job openings to the total number of people unemployed. The figure shows that in July 2022 there were almost two jobs available for each person who was unemployed.

Typically, a strong job market with high rates of job openings indicates that firms are expanding and that they expect their profits to be increasing. As we discuss in Macroeconomics, Chapter 6, Section 6.2 (Microeconomics and Economics, Chapter 8, Section 8.2) the price of a stock is determined by investors’ expectations of the future profitability of the firm issuing the stock. So, we might have expected that on the day the BLS released the July JOLTS report containing good news about the labor market, the stock market indexes like the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index would rise. In fact, though the indexes fell, with the Dow Jones Industrial Average declining a substantial 300 points. As a column in the Wall Street Journal put it: “A surprisingly tight U.S. labor market is rotten news for stock investors.” Why did good news about the labor market could cause stock prices to decline? The answer is found in investors’ expectations of the effect the news would have on monetary policy.

In August 2022, Fed Chair Jerome Powell and the other members of the Federal Reserve Open Market Committee (FOMC) were in the process of tightening monetary policy to reduce the very high inflation rates the U.S. economy was experiencing. In July 2022, inflation as measured by the percentage change in the consumer price index (CPI) was 8.5 percent. Inflation as measured by the percentage change in the personal consumption expenditures (PCE) price index—which is the measure of inflation that the Fed uses when evaluating whether it is hitting its target of 2 percent annual inflation—was 6.3 percent. (For a discussion of the Fed’s choice of inflation measure, see the Apply the Concept “Should the Fed Worry about the Prices of Food and Gasoline,” in Macroeconomics, chapter 15, Section 15.5 and in Economics, Chapter 25, Section 25.5.)

To slow inflation, the FOMC was increasing its target for the federal funds rate—the interest rate that banks charge each other on overnight loans—which in turn was leading to increases in other interest rates, such as the interest rate on residential mortgage loans. Higher interest rates would slow increases in aggregate demand, thereby slowing price increases. How high would the FOMC increase its target for the federal funds rate? Fed Chair Powell had made clear that the FOMC would monitor economic data for indications that economic activity was slowing. Members of the FOMC were concerned that unless the inflation rate was brought down quickly, the U.S. economy might enter a wage-price spiral in which high inflation rates would lead workers to push for higher wages, which, in turn, would increase firms’ labor costs, leading them to raise prices further, in response to which workers would push for even higher wages, and so on. (We discuss the concept of a wage-price spiral in this earlier blog post.)

In this context, investors interpretated data showing unexpected strength in the economy—particularly in the labor market—as making it likely that the FOMC would need to make larger increases in its target for the federal fund rate. The higher interest rates go, the more likely that the U.S. economy will enter an economic recession. During recessions, as production, income, and employment decline, firms typically experience lower profits or even suffer losses. So, a good JOLTS report could send stock prices falling because news that the labor market was stronger than expected increased the likelihood that the FOMC’s actions would push the economy into a recession, reducing profits. Or as the Wall Street Journal column quoted earlier put it:

“So Tuesday’s [JOLTS] report was good news for workers, but not such good news for stock investors. It made another 0.75-percentage-point rate increase [in the target for the federal funds rate] from the Fed when policy makers meet next month seem increasingly likely, while also strengthening the case that the Fed will keep raising rates well into next year. Stocks sold off sharply following the report’s release.”

Sources: U.S. Bureau of Labor Statistics, “Job Openings and Labor Turnover–July 2022,” bls.gov, August 30, 2022; Justin Lahart, “Why Stocks Got Jolted,” Wall Street Journal, August 30, 2022; Jerome H. Powell, “Monetary Policy and Price Stability,” speech at “Reassessing Constraints on the Economy and Policy,” an economic policy symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26, 2022; and Federal Reserve Bank of St. Louis.

Is the U.S. Economy in a Recession? Real GDP versus Real GDI

Photo from the Wall Street Journal.

The Bureau of Economic Analysis (BEA) publishes data on gross domestic product (GDP) each quarter. Economists and media reports typically focus on changes in real GDP as the best measure of the overall state of the U.S. economy. But, as we discuss in Macroeconomics, Chapter 8, Section 8.4 (Economics, Chapter 18, Section 18.4), the BEA also publishes quarterly data on gross domestic income (GDI). As we discuss in Chapter 8, Section 8.1 when discussing the circular-flow diagram, the value of every final good and services produced in the economy (GDP) should equal the value of all the income in the economy resulting from that production (GDI). The BEA has designed the two measures to be identical by including in GDI some non-income items, such as sales taxes and depreciation. But as we discuss in the Apply the Concept, “Should We Pay More Attention to Gross Domestic Income?” GDP and GDI are compiled by the BEA from different data sources and can sometimes significantly diverge. 

A large divergence between the two measures occurred in the first half of 2022. During this period real GDP declined—as shown by the blue line in the following figure—after which some stories in the media indicated that the U.S. economy was in a recession.  But real GDI—as shown by the red line in the figure—increased during the same two quarters. So, was the U.S. economy still in the expansion that began in the third quarter of 2020, rather than in a recession?  Or, as an article in the Wall Street Journal put it: “A Different Take on the U.S. Economy: Maybe It Isn’t Really Shrinking.”

In fact, most economists do not follow the popular definition of a recession as being two consecutive quarters of declining real GDP. Instead, as we discuss in Chapter 10, Section 10.3, economists typically follow the definition of a recession used by the National Bureau of Economic Research: “A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” 

During the first half of 2022, most measures of economic activity were expanding, rather than contracting. For example, the first of the following figures shows payroll employment increasing in each month in the first half of 2022. The second figure shows industrial production also increasing during most months in the first half of 2022, apart from a very slight decline from April to May after which it continued to increase. 

Taken together, these data indicate that the U.S. economy was likely not in a recession during the first half of 2022. The BEA revises the data on real GDP and real GDI over time as various government agencies gather more information on the different production and income measures included in the series. Jeremy Nalewaik of the Federal Reserve Board of Governors has analyzed the BEA’s adjustments to its initial estimates of real GDP and real GDI. He has found that when there are significant differences between the two series, the BEA revisions usually result in the GDP values being revised to be closer to the GDI values. Put another way, the initial GDI estimates may be more accurate than the initial GDP estimates.

If that generalization holds true in 2022, then the BEA may eventually revise its estimates of GDP upward, which would show that the U.S. economy was not in a recession in the first of half of 2022 because economic activity was increasing rather than decreasing. 

Sources: Jon Hilsenrath, “A Different Take on the U.S. Economy: Maybe It Isn’t Really Shrinking,” Wall Street Journal, August 28, 2022; Reade Pickert, “Key US Growth Measures Diverge, Complicating Recession Debate,” bloomberg.com, August 25, 2022; Jeremy L. Nalewaik, “The Income- and Expenditure-Side Estimates of U.S. Output Growth,” Brookings Papers on Economic Activity, Spring 2010, pp. 71-127; and Federal Reserve Bank of St. Louis.

How Should We Measure Inflation?

Image from the Wall Street Journal.

In the textbook, we discuss several measures of inflation. In Macroeconomics, Chapter 8, Section 8.4 (Economics, Chapter 18, Section 18.4) we discuss the GDP deflator as a measure of the price level and the percentage change in the GDP deflator as a measure of inflation. In Chapter 9, Section 9.4, we discuss the consumer price index (CPI) as a measure of the price level and the percentage change in the CPI as the most widely used measure of inflation. 

            In Chapter 15, Section 15.5 we examine the reasons that the Federal Reserve often looks at the core inflation rate—the inflation rate excluding the prices of food and energy—as a better measure of the underlying rate of inflation. Finally, in that section we note that the Fed uses the percentage change in the personal consumption expenditures (PCE) price index to assess  of whether it’s achieving its goal of a 2 percent inflation rate.

            In this blog post, we’ll discuss two other aspects of measuring inflation that we don’t cover in the textbook. First, the Bureau of Labor Statistics (BLS) publishes two versions of the CPI:  (1) The familiar CPI for all urban consumers (or CPI–U), which includes prices of goods and services purchased by households in urban areas, and (2) the less familiar CPI for urban wage earners and clerical workers (or CPI–W), which includes the same prices included in the CPI–U. The two versions of the CPI give slightly different measures of the inflation rate—despite including the same prices—because each version applies different weights to the prices when constructing the index.

            As we explain in Chapter 9, Section 9.4, the weights in the CPI–U (the only version of the CPI we discuss in the chapter) are determined by a survey of 36,000 households nationwide on their spending habits. The more the households surveyed spend on a good or service, the larger the weight the price of the good or service receives in the CPI–U. To calculate the weights in the CPI–W the BLS uses only expenditures by households in which at least half of the household’s income comes from a clerical or wage occupation and in which at least one member of the household has worked 37 or more weeks during the previous year.  The BLS estimates that the sample of households used in calculating the CPI–U includes about 93 percent of the population of the United States, while the households included in the CPI–W include only about 29 percent of the population. 

            Because the percentage of the population covered by the CPI–U is so much larger than the percentage of the population covered by the CPI–W, it’s not surprising that most media coverage of inflation focuses on the CPI–U. As the following figure shows, the measures of inflation from the two versions of the CPI aren’t greatly different, although inflation as measured by the CPI–W—the red line—tends to be higher during economic expansions and lower during economic recessions than inflation measured by the CPI–U—the blue line. 

One important use of the CPI–W is in calculating cost-of-living adjustments (COLAs) applied to Social Security payments retired and disabled people receive. Each year, the federal government’s Social Security Administration (SSA) calculates the average for the CPI–W during June, July, and August in the current year and in the previous year and then measures the inflation rate as the percentage increase between the two averages. The SSA then increases Social Security payments by that inflation rate. Because the increase in CPI–W is often—although not always—larger than the increase in CPI–U, using CPI–W to calculate Social Security COLAs increases the payments recipients of Social Security receive. 

            A second aspect of measuring inflation that we don’t mention in the textbook was the subject of discussion following the release of the July 2022 CPI data. In June 2022, the value for the CPI–U was 295.3. In July 2022, the value for the CPI–U was also 295.3. So, was there no inflation during July—an inflation rate of 0 percent? You can certainly make that argument, but typically, as we note in the textbook (for instance, see our display of the inflation rate in Chapter 10, Figure 10.7) we measure the inflation rate in a particular month as the percentage change in the CPI from the same month in the previous year. Using that approach to measuring inflation, the inflation rate in July 2022 was the percentage change in the CPI from its value in July 2021, or 8.5 percent.  Note that you could calculate an annual inflation rate using the increase in the CPI from one month to the next by compounding that rate over 12 months. In this case, because the CPI was unchanged from June to July 2022, the inflation rate calculated as a compound annual rate would be 0 percent.  

            During periods of moderate inflation rates—which includes most of the decades prior to 2021—the difference between inflation calculated in these two ways was typically much smaller. Focusing on just the change in the CPI for one month has the advantage that you are using only the most recent data. But if the CPI in that month turns out to be untypical of what is happening to inflation over a longer period, then focusing on that month can be misleading. Note also that inflation rate calculated as the compound annual change in the CPI each month results in very large fluctuations in the inflation rate, as shown in the following figure.

Sources: Anne Tergesen, “Social Security Benefits Are Heading for the Biggest Increase in 40 Years,” Wall Street Journal, August 10, 2022; Neil Irwin, “Inflation Drops to Zero in July Due to Falling Gas Prices,” axios.com, August 10, 2022; “Consumer Price Index Frequently Asked Questions,” bls.gov, March 23, 2022; Stephen B. Reed and Kenneth J. Stewart, “Why Does BLS Provide Both the CPI–W and CPI–U?” U.S. Bureau of Labor Statistics, Beyond the Numbers, Vol. 3, No. 5, February 2014; “Latest Cost of Living Adjustment,” ssa.gov; and Federal Reserve Bank of St. Louis.

Senator Elizabeth Warren vs. Economist Lawrence Summers on Monetary Policy

Senator Elizabeth Warren (Photo from the Associated Press)

Lawrence Summers (Photo from harvardmagazine.com)

As we’ve discussed in several previous blog posts, in early 2021 Lawrence Summers, professor of economics at Harvard and secretary of the treasury in the Clinton administration, argued that the Biden administration’s $1.9 trillion American Rescue Plan, enacted in March, was likely to cause a sharp acceleration in inflation. When inflation began to rapidly increase, Summers urged the Federal Reserve to raise its target for the federal funds rate in order to slow the increase in aggregate demand, but the Fed was slow to do so. Some members of the Federal Open Market Committee (FOMC) argued that much of the inflation during 2021 was transitory in that it had been caused by lingering supply chain problems initially caused by the Covid–19 pandemic. 

At the beginning of 2022, most members of the FOMC became convinced that in fact increases in aggregate demand were playing an important role in causing high inflation rates.  Accordingly, the FOMC began increasing its target for the federal funds rate in March 2022. After two more rate increases, on the eve of the FOMC’s meeting on July 26–27, the federal funds rate target was a range of 1.50 percent to 1.75 percent. The FOMC was expected to raise its target by at least 0.75 percent at the meeting. The following figure shows movements in the effective federal funds rate—which can differ somewhat from the target rate—from January 1, 2015 to July 21, 2022.

In an opinion column in the Wall Street Journal, Massachusetts Senator Elizabeth Warren argued that the FOMC was making a mistake by increasing its target for the federal funds rate. She also criticized Summers for supporting the increases. Warren worried that the rate increases were likely to cause a recession and argued that Congress and President Biden should adopt alternative measures to contain inflation. Warren argued that a better approach to dealing with inflation would be to, among other steps, increase the federal government’s support for child care to enable more parents to work, provide support for strengthening supply chains, and lower prescription drug prices by allowing Medicare to negotiate the prices with pharmaceutical firms. She also urged a “crack down on price gouging by large corporations.” (We discussed the argument that monopoly power is responsible for inflation in this blog post.)

 Summers responded to Warren in a Twitter thread. He noted that: “In the 18 months since the massive stimulus policies & easy money that [Senator Warren] has favored & I have opposed, the inflation rate has risen from below 2 to above 9 percent & workers purchasing power has, as a consequence, declined more rapidly than in any year in the last 50.” And “[Senator Warren] opposes restrictive monetary policy or any other measure to cool off total demand.  Why does she think at a time when there are twice as many vacancies as jobs that inflation will come down without some drop in total demand?”

Clearly, economists and policymakers continue to hotly debate monetary policy.

Source: Elizabeth Warren, “Jerome Powell’s Fed Pursues a Painful and Ineffective Inflation Cure,” Wall Street Journal, July 24, 2022.

An Index to Measure Supply Chain Problems

Photo of the Port of Los Anglese from the Wall Street Journal.

In economics, index numbers play an important role in gauging the state of the economy. For instance, rather than measure inflation by looking at the price of one or a few goods and services, we use the consumer price index (CPI), which combines the prices of many goods and services into a single number. (In Macroeconomics, Chapter 9, Section 9.4 and Economics, Chapter 19, Section 19.4, we discuss how the Bureau of Labor Statistics constructs the consumer price index.) Similarly, the S&P 500 provides an index of stock prices and the Federal Reserve compiles an index of industrial production that measures the output of factories, mines, and utilities.

            The advantage of indexes is that they provide broader measures of an economic variable. Important as the price of gasoline is in the average family’s budget, the prices of food, clothing, and other goods and services are also important. So, the CPI is a better measure of inflation than is just the price of gasoline.

            But in some cases it can be difficult for economists to construct an index. This problem is particularly likely when an index would not be comprised of similar data, such as prices of goods and services in the case of the CPI. For example, when the Covid–19 pandemic first began to affect the United States in March 2020, the U.S. economy began to experience “supply chain problems.” News articles reported supply chains problems persisting into the summer of 2022. These reports highlighted specific problems, such as shortages of semiconductors that reduced automobile production and ships being backed up at ports leading to delays in U.S. firms receiving imported products. Just as we don’t want to measure inflation by looking only at gasoline prices, we don’t want to measure supply chain problems by looking only at shortages of semiconductors. It would be better to use an index that summarizes what is happening with supply chains in a way that’s analogous to how the CPI summarizes what is happening with the price level. But the very different aspects of supply chain problems make constructing an index that summarizes these problems more difficult than constructing the CPI. 

            Economists at the Federal Reserve Bank of New York have tried to overcome these technical difficulties in devising an index of supply chain problems: the Global Supply Chain Pressure Index (GSCPI). Here’s the New York Fed’s description of the economic data included in the index:

“The GSCPI integrates a number of commonly used metrics with the aim of providing a comprehensive summary of potential supply chain disruptions. Global transportation costs are measured by employing data from the Baltic Dry Index (BDI) and the Harpex index, as well as airfreight cost indices from the U.S. Bureau of Labor Statistics. The GSCPI also uses several supply chain-related components from Purchasing Managers’ Index (PMI) surveys, focusing on manufacturing firms across seven interconnected economies: China, the euro area, Japan, South Korea, Taiwan, the United Kingdom, and the United States.”

Some more detail on components of the index that may be unfamiliar: The Baltic Dry Index (BDI) and the Harpex indexes both measure rates shippers charge firms to move cargo by sea. (Note that the name “Baltic” has historical significance but doesn’t mean that the index covers only the price of shipping in the Baltic Sea.) The Purchasing Managers’ Index (PMI) is derived from surveying purchasing managers at firms around the world about such aspects of their businesses as order backlogs, new orders, delivery time of goods from suppliers, inventories, and costs.  

The following figure shows movements in the GSCPI from January 1998 through June 2022 and is derived from data on the New York Fed site.  Higher values indicate more supply chain problems in the world economy. Movements in the index indicate that supply chain problems reached a peak in April 2020 during the height of the initial disruptions caused by the pandemic. Supply chains then improved through September 2020 before worsening again. The worst reading for the index occurred in December 2021. Supply problems then eased during the first half of 2022, although the index still remained high in June 2022. (Note that the values on the vertical axis are standard deviations from the average values of the index over the whole period. The standard deviation is a statistical measure of how spread out values of a series are relative to the series’ average value. That the value for the index during the first half of 2022 was two to four standards deviations above the average of the index indicates that supply chain problems were much more severe than normal.)

Sources: Liz Young, “Companies Face Rising Supply-Chain Costs Amid Inventory Challenges,” Wall Street Journal, June 21, 2022; Ana Monteiro, “Supply Constrainst a Headache for U.S. Firms as Outlook Dims,” bloomberg.com, June 2, 2022; and Federal Reserve Bank of New York, Global Supply Chain Pressure Index, https://www.newyorkfed.org/research/gscpi.html.

Be Careful When Interpreting Macroeconomic Data at the Beginning of a Recession

On Friday, July 8, the Bureau of Labor Statistics (BLS) released its monthly “Employment Situation” report for June 2022. The BLS estimated that nonfarm employment had increased by 372,000 during the month. That number was well above what economic forecasters had expected and seemed inconsistent with other macroeconomic data that showed the U.S. economy slowing. (Note that the increase in employment is from the establishment survey, sometimes called the payroll survey, which we discuss in Macroeconomics, Chapter 9, Section 9.1 and Economics, Chapter 19, Section 19.1.)

Data indicating that the economy was slowing during the first half of 2022 include the Bureau of Economic Analysis’s (BEA) estimate that real GDP had declined by 1.6 percent in the first quarter of 2022. The BEA’s advance estimate—the agency’s first estimate for the quarter—for the change in real GDP during the second quarter of 2022 won’t be released until July 28, but there are indications that real GDP will have declined again during the second quarter.  For instance, the Federal Reserve Bank of Atlanta compiles a forecast of real GDP called GDPNow. The GDPNow forecast uses data that are released monthly on 13 components of GDP. This method allows economists at the Atlanta Fed to issue forecasts of real GDP well in advance of the BEA’s estimates. On July 8, the GDPNow forecast was that real GDP in the second quarter of 2022 would decline by 1.2 percent.

Two consecutive quarters of declining real GDP seems inconsistent with employment strongly growing. At a basic level, if firms are producing fewer goods and services—which is what causes a decline in real GDP—we would expect the firms to be reducing, rather than increasing, the number of people they employ. How can we reconcile the seeming contradiction between rising employment and falling output? One possibility is that either the real GDP data or the employment data—or, possibly, both—are inaccurate. Both GDP data and employment data from the establishment survey are subject to potentially substantial future revisions. (Note that because they are constructed from a survey of households, the employment data in the household survey aren’t revised. As we discuss in the text, economists and policymakers typically rely more on the establishment survey than on the household survey in gauging the current state of the labor market.) Substantial revisions are particularly likely for data released during the beginning of a recession. 

In Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), we give an example of substantial revisions in the employment data. Figure 9.5 (reproduced below) shows that the declines in employment during the 2007–2009 recession were initially greatly underestimated. For example, the BLS initially reported that employment declined by 159,000 during September 2008. But after additional data became available, the BLS revised its estimate to a much larger decline of 460,000.

Similarly, in Macroeconomics, Chapter 15, Section 15,3, in the Apply the Concept “Trying to Hit a Moving Target: Making Policy with ‘Real-Time Data’,” we show the BEA’s estimates of the change in real GDP during the first quarter of 2008 have been revised substantially over time. The BEA’s advance estimate of the change in real GDP during the first quarter of 2008 was an increase of 0.6 percent at an annual rate. But that estimate of real GDP growth has been revised a number of times over the years, mostly downward. Currently, BEA data indicate that real GDP actually declined by 1.6 percent at an annual rate during the first quarter of 2008. This swing of more than 2 percentage points from the advance estimate is a large difference, which changes the picture of what happened during the first quarter of 2008 from one of an economy experiencing slow growth to one of an economy suffering a sharp downturn as it fell into the worst recession since the Great Depression of the 1930s.

The changes to the estimates of both employment and real GDP during the beginning of the 2007–2009 recession are not surprising. The initial estimates of employment and real GDP rely on incomplete data. The estimates are revised as additional data are collected by government agencies. During the beginning of a recession, these additional data are likely to show lower levels of employment and output than were indicated by the initial estimates. If the U.S. economy is in a recession in the second quarter of 2022, we can expect that the BLS and BEA will revise their initial estimates of employment and real GDP downward, which—depending on the relative magnitudes of the revisions to the two series—may resolve the paradox of rising employment and falling output. 

Or it’s possible that the U.S. economy is not in a recession. In that case, the employment data may be correct in showing an increase in the number of people working, and the real GDP data may be revised upward to show that output has actually been expanding during the first six months of 2022. Economists and policymakers will have to wait to see which of these alternatives turns out to be the case.

More on Hidden Inflation

This yogurt remained the same price although the container shrank from 5.3 ounces to 4.5 ounces.

Each month, hundreds of employees of the Bureau of Labor Statistics (BLS) gather data on prices of goods and services from stores in 87 cities and from websites. The BLS constructs the consumer price index (CPI) by giving each price a weight equal to the fraction of a typical family’s budget spent on that good or service. (CPI is discussed in Macroeconomics, Chapter 9, Section 9.4 and in Economics, Chapter 19, Section 19.4.) Ideally, the BLS tracks prices of the same product over time. But sometimes a particular brand and style of shirt, for example, is discontinued. In that case, the BLS will instead use the price of a shirt that is a very close substitute.

A more difficult problem arises when the price of a good increases at the same time that the quality of the good improves. For instance, a new model iPhone may have both a higher price and a better battery than the model it replaces, so the higher price partly reflects the improvement in the quality of the phone. The BLS has long been aware of this problem and has developed statistical techniques that attempt to identify which part of the price increases are due to increases in quality. Economists differ in their views on how successfully the BLS has dealt with this quality bias to the measured inflation rate. Because of this bias in constructing the CPI, it’s possible that the published values of inflation may overstate the actual annual rate of inflation by 0.5 percentage point. For instance, the BLS might report an inflation rate of 3.5 percent when the actual inflation rate—if the BLS could determine it—was 4.0 percent.
As the inflation rate increased beginning in the spring of 2021, a number of observers pointed to hidden inflation that was occurring. There were two main types of hidden inflation:

  1. The quality of some services was declining
  2. Some packaged goods contained smaller quantities at the same price

Here’s one example of the deteriorating quality of some services. Because during 2021 and 2022 many restaurants were having difficulty hiring servers, it was often taking longer for customers to have their orders taken and to have their food brought to the table. Because restaurants were also having difficulty hiring enough cooks, they also limited the items available on their menus. In other words, the service these restaurants were offering was not as good as it had been prior to the pandemic. So even if the restaurants kept their prices unchanged, their customers were paying the same price, but receiving less.
Alan Cole, a former senior economist with the Congressional Joint Economic Committee, discussed these other examples on his blog: “hotels clean rooms less frequently on multi-night stays, shipping delays are longer, and phone hold times at airlines are worse.” In a column in the New York Times, economics writer Neil Irwin made similar points: “Complaints have been frequent about the cleanliness of [restaurant] tables, floors and bathrooms.” And: “People trying to buy appliances and other retail goods are waiting longer.”

A column in the Wall Street Journal on business travel by Scott McCartney was headlined “The Incredible Disappearing Hotel Breakfast.” McCartney noted that many hotels continue to advertise free hot breakfasts on their websites and apps but have stopped providing them. He also noted that hotels “have suffered from labor shortages that have made it difficult to supply services such as daily housekeeping or loyalty-group lounges,” in addition to hot breakfasts.
In all of these cases, the actual prices of the services had increased more than had the listed prices because the deterioration in quality meant that people were receiving less for their money.


In addition to deterioration in the quality of services, hidden inflation during this period also took the form of consumers buying some packaged goods in which the quantities had been reduced, although the price was unchanged. For example, in June 2022, an article by the Associated Press noted that:


• “A small box of Kleenex now has 60 tissues; a few months ago, it had 65.”
• “Chobani Flips yogurts have shrunk from 5.3 ounces to 4.5 ounces.”
• “Earth’s Best Organic Sunny Days Snack Bars went from eight bars per box to seven, but the price listed at multiple stores remains $3.69.”


An article in the Wall Street Journal observed that: “Shrinkflation, as economists call it, tends to be easier for companies to pass on to consumers. Despite labels that show price by weight, research shows that most customers look at only the overall price.”


The BLS does try to adjust the measurement of the CPI for shrinkflation, which it can do because the BLS keeps careful track of the quantities included in the packaged goods that are included in its survey.


But the BLS makes no attempt to adjust the CPI for the deterioration in the quality of services because doing so would be very difficult. As Irwin observes: “Customer service preferences—particularly how much good service is worth—varies highly among individuals and is hard to quantify. How much extra would you pay for a fast-food hamburger from a restaurant that cleans its restroom more frequently than the place across the street?” And an economist at the BLS noted that, “We do not capture the decrease in service quality associated with cleaning a [hotel] room every two days rather than one.”


As we noted earlier, most economists believe that the failure of the BLS to fully account for improvements in the quality of goods results in changes in the CPI overstating the true inflation rate. This bias may have been more than offset during 2021–2022 by deterioration in the quality of services resulting in the CPI understating the true inflation rate. As the dislocations caused by the pandemic gradually resolve themselves, it seems likely that the deterioration in services will be reversed. But it’s possible that the deterioration in the provision of some services may persist. Fortunately, unless the deterioration increases over time, it would not continue to distort the measurement of the inflation rate because the same lower level of service would be included in every period’s prices.


Sources: Dee-Ann Durbin, “No, You’re Not Imagining It—Package Sizes Are Shrinking,” apnews.com, June 8, 2022; Annie Gasparro and Gabriel T. Rubin, “The Hidden Ways Companies Raise Prices,” Wall Street Journal, February 12, 2022; Alan Cole, “How I Reluctantly Became an Inflation Crank,” fullstackeconomics.com, September 8, 2021; Scott McCartney, “The Incredible Disappearing Hotel Breakfast—and Other Amenities Travelers Miss,” Wall Street Journal, October 20, 2021; and Neil Irwin, “There Is Shadow Inflation Taking Place All Around Us,” New York Times, October 14, 2021.

Was the High Inflation of 2021–2022 Due to Shifts in Aggregate Demand or Shifts in Aggregate Supply?

Man surprised by inflation in food prices.

To answer the question in the title:  Negative supply shocks—shifts to the left in the short-run aggregate supply (SRSAS) curve—and positive demand shocks—shifts to the right in the aggregate demand (AD) curve—both contributed to the acceleration in inflation that began in the spring of 2021. But were the aggregate supply shifts, such as the semiconductor shortage that reduced the supply of new automobiles, more or less important than the aggregate demand shifts, such as the expansionary monetary and fiscal policies?

Adam Hale Shapiro of the Federal Reserve Bank of San Francisco used a basic piece of microeconomic analysis to estimate the contribution of shifts in aggregate supply and shifts in aggregate demand to inflation during this period. He looked at the prices of the more than 100 categories of goods and services in the personal consumption expenditures(PCE) price index. The PCE price index is a measure of the price level similar to the GDP deflator, except it includes only the prices of goods and services from the consumption category of GDP. Changes in the PCE price index are the Federal Reserve’s preferred measure of the inflation rate because that index includes the prices of more goods and services than are included in the consumer price index (CPI).

Shapiro explains how he used microeconomic reasoning to determine whether prices in one of the more than 100 categories of goods and services were increasing because of shifts in supply or because of shifts in demand:

“Shifts in demand move both prices and quantities in the same direction along the upward-sloping supply curve, meaning prices rise as demand increases. Shifts in supply move prices and quantities in opposite directions along the downward-sloping demand curve, meaning prices rise when supplies decline.”

 For example, the figure on the left shows the effect on the market for toys of an increase in the demand for toys. (We discuss how shifts in demand and supply curves in a market affect equilibrium price and quantity in Chapter 3, Section 3.4 of Economics, Macroeconomics, and Microeconomics.) The demand curve for toys shifts to the right from D1 to D2, the equilibrium price increases from P1 to P2, and the equilibrium quantity increases from Q1 to Q2. The figure on the right shows the effect on the market for toys if the price increase results from a decrease in the supply of toys rather than from an increase in demand. The supply curve shifts to the left from S1 to S2, the equilibrium price increases from P1 to P2, and the equilibrium quantity decreases from Q1 to Q2. 

Shapiro used statistical methods to determine the part of a change in price or quantity that was unexpected. He took this approach in order to focus on short-run changes in these markets caused by shifts in demand and supply rather than long-run changes resulting from “factors such as technological improvements, cost-of-living adjustments to wages, or demographic changes like population aging.” In some cases, the quantity or the price in a market were very close to their expected values, so Shapiro labeled the cause of a price increase in this market as “ambiguous.”

Shapiro notes that: “Categories that experience frequent supply-driven price changes include food and household products such as dishes, linens, and household paper items. Categories that experience frequent demand-driven price changes include motor vehicle-related products, used cars, and electricity.”

The following figure shows Shapiro’s results for the period from January 2020 through April 2022. The height of each column gives the inflation rate in the month measured as the percentage change in the PCE price index from the same month in the previous year. For example, in March 2022, the inflation rate was 6.6 percent. The height of the yellow segment is the part of inflation in that month attributable to increases in demand, the height of the green segment is the part of the inflation in that month that is attributable to decreases in supply, and the height of the green segment is the part of the inflation that Shapiro can’t assign to either demand or supply. In March 2022, increased in demand accounted for 2.2 percentage points of the total 6.6 percentage point increase in inflation. Decreases in supply accounted for 3.3 percentage points, and the remaining 1.2 percentage points had an ambiguous cause. 

We can conclude that, measured this way, the increase in inflation from the spring of 2021 through the spring of 2022 was due more to negative supply shocks than to positive demand shocks.

Source: Adam Hale Shapiro, “How Much Do Supply and Demand Drive Inflation?” Federal Reserve Bank of San Francisco Economic Letter, 22-15, June 21, 2022.

Are the Fed’s Forecasts of Inflation and Unemployment Inconsistent?

The Federal Reserve building in Washington, DC. Photo from the Wall Street Journal.

Four times per year, the members of the Federal Reserve’s Federal Open Market Committee (FOMC) publish their projections, or forecasts, of the values of the inflation rate, the unemployment, and changes in real gross domestic product (GDP) for the current year, each of the following two years, and for the “longer run.”  The following table, released following the FOMC meeting held on March 15 and 16, 2022, shows the forecasts the members made at that time.

  Median Forecast Meidan Forecast Median Forecast 
 202220232024Longer runActual values, March 2022
Change in real GDP2.8%2.2%2.2%1.8%3.5%
Unemployment rate3.5%3.5%3.6%4.0%3.6%
PCE inflation4.3%2.7%2.3%2.0%6.6%
Core PCE inflation4.1%2.6%2.3%No forecast5.2%

Recall that PCE refers to the consumption expenditures price index, which includes the prices of goods and services that are in the consumption category of GDP. Fed policymakers prefer using the PCE to measure inflation rather than the consumer price index (CPI) because the PCE includes the prices of more goods and services. The Fed uses the PCE to measure whether it is hitting its target inflation rate of 2 percent. The core PCE index leaves out the prices of food and energy products, including gasoline. The prices of food and energy products tend to fluctuate for reasons that do not affect the overall long-run inflation rate. So Fed policymakers believe that core PCE gives a better measure of the underlying inflation rate. (We discuss the PCE and the CPI in the Apply the Concept “Should the Fed Worry about the Prices of Food and Gasoline?” in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5)).

The values in the table are the median forecasts of the FOMC members, meaning that the forecasts of half the members were higher and half were lower.  The members do not make a longer run forecast for core PCE.  The final column shows the actual values of each variable in March 2022. The values in that column represent the percentage in each variable from the corresponding month (or quarter in the case of real GDP) in the previous year.  Links to the FOMC’s economic projections can be found on this page of the Federal Reserve’s web site.

At its March 2022 meeting, the FOMC began increasing its target for the federal funds rate with the expectation that a less expansionary monetary policy would slow the high rates of inflation the U.S. economy was experiencing. Note that in that month, inflation measured by the PCE was running far above the Fed’s target inflation rate of 2 percent. 

In raising its target for the federal funds rate and by also allowing its holdings of U.S. Treasury securities and mortgage-backed securities to decline, Fed Chair Jerome Powell and the other members of the FOMC were attempting to achieve a soft landing for the economy. A soft landing occurs when the FOMC is able to reduce the inflation rate without causing the economy to experience a recession. The forecast values in the table are consistent with a soft landing because they show inflation declining towards the Fed’s target rate of 2 percent while the unemployment rate remains below 4 percent—historically, a very low unemployment rate—and the growth rate of real GDP remains positive. By forecasting that real GDP would continue growing while the unemployment rate would remain below 4 percent, the FOMC was forecasting that no recession would occur.

Some economists see an inconsistency in the FOMC’s forecasts of unemployment and inflation as shown in the table. They argued that to bring down the inflation rate as rapidly as the forecasts indicated, the FOMC would have to cause a significant decline in aggregate demand. But if aggregate demand declined significantly, real GDP would either decline or grow very slowly, resulting in the unemployment rising above 4 percent, possibly well above that rate.  For instance, writing in the Economist magazine, Jón Steinsson of the University of California, Berkeley, noted that the FOMC’s “combination of forecasts [of inflation and unemployment] has been dubbed the ‘immaculate disinflation’ because inflation is seen as falling rapidly despite a very tight labor market and a [federal funds] rate that is for the most part negative in real terms (i.e., adjusted for inflation).”

Similarly, writing in the Washington Post, Harvard economist and former Treasury secretary Lawrence Summers noted that “over the past 75 years, every time inflation has exceeded 4 percent and unemployment has been below 5 percent, the U.S. economy has gone into recession within two years.”

In an interview in the Financial Times, Olivier Blanchard, senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund, agreed. In their forecasts, the FOMC “had unemployment staying at 3.5 percent throughout the next two years, and they also had inflation coming down nicely to two point something. That just will not happen. …. [E]ither we’ll have a lot more inflation if unemployment remains at 3.5 per cent, or we will have higher unemployment for a while if we are actually to inflation down to two point something.”

While all three of these economists believed that unemployment would have to increase if inflation was to be brought down close to the Fed’s 2 percent target, none were certain that a recession would occur.

What might explain the apparent inconsistency in the FOMC’s forecasts of inflation and unemployment? Here are three possibilities:

  1. Fed policymakers are relatively optimistic that the factors causing the surge in inflation—including the economic dislocations due to the Covid-19 pandemic and the Russian invasion of Ukraine and the surge in federal spending in early 2021—are likely to resolve themselves without the unemployment rate having to increase significantly. As Steinsson puts it in discussing this possibility (which he believes to be unlikely) “it is entirely possible that inflation will simply return to target as the disturbances associated with Covid-19 and the war in Ukraine dissipate.”
  2. Fed Chair Powell and other members of the FOMC were convinced that business managers, workers, and investors still expected that the inflation rate would return to 2 percent in the long run. As a result, none of these groups were taking actions that might lead to a wage-price spiral. (We discussed the possibility of a wage-price spiral in earlier blog post.) For instance, at a press conference following the FOMC meeting held on May 3 and 4, 2022, Powell argued that, “And, in fact, inflation expectations [at longer time horizons] come down fairly sharply. Longer-term inflation expectations have been reasonably stable but have moved up to—but only to levels where they were in 2014, by some measures.” If Powell’s assessment was correct that expectations of future inflation remained at about 2 percent, the probability of a soft landing was increased.
  3. We should mention the possibility that at least some members of the FOMC may have expected that the unemployment rate would increase above 4 percent—possibly well above 4 percent—and that the U.S. economy was likely to enter a recession during the coming months. They may, however, have been unwilling to include this expectation in their published forecasts. If members of the FOMC state that a recession is likely, businesses and households may reduce their spending, which by itself could cause a recession to begin. 

Sources: Martin Wolf, “Olivier Blanchard: There’s a for Markets to Focus on the Present and Extrapolate It Forever,” ft.com, May 26, 2022; Lawrence Summers, “My Inflation Warnings Have Spurred Questions. Here Are My Answers,” Washington Post, April 5, 2022; Jón Steinsson, “Jón Steinsson Believes That a Painless Disinflation Is No Longer Plausible,” economist.com, May 13, 2022; Federal Open Market Committee, “Summary of Economic Projections,” federalreserve.gov, March 16, 2022; and Federal Open Market Committee, “Transcript of Chair Powell’s Press Conference May 4, 2022,” federalreserve.gov, May 4, 2022.