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In the Face of Hyperinflation, Some People in Argentina Don’t Save Currency, They Save … Bricks

Argentina’s Argentina’s Economy Minister Sergio Massa coming from a meeting in Washington, DC with the International Monetary Fund to discuss the country’s hyperinflation. Photo from the Wall Street Journal.

Argentina has been through several periods of hyperinflation during with the price level has increased more than 50 percent per month. The following figure shows the inflation rate as measured by the percentage change in the consumer price index from the previous month for since the beginning of 2018. The inflation rate during these years has been volatile, being greater than 50 percent per month during several periods, including staring in the spring of 2022. High rates of inflation have become so routine in Argentina that an article in the Wall Street Journal quoted on store owner as saying, “Here 40% [inflation] is normal. And when we get past 50%, it doesn’t scare us, it simply bothers us.”

As we discuss in Macroeconomics, Chapter 14, Section 14.5 (Economics, Chapter 24, Section 24.5 ), when an economy experiences hyperinflation, consumers and businesses hold the country’s currency for as brief a time as possible because the purchasing power of the currency is declining rapidly. As we noted in the chapter, in some countries experiencing high rates of inflation, consumers and businesses buy and sell goods using U.S. dollars rather than the domestic currency because the purchasing power of the dollar is more stable. This demand for dollars in countries experiencing high inflation rates is one reason why an estimated 80 percent of all $100 bills circulate outside of the United States. 

The increased demand for U.S. dollars by people in Argentina is reflected in the exchange rate between the Argentine peso and the U.S. dollar. The following figure shows that at the beginning of 2018, one dollar exchanged for about 18 pesos. By November 2022, one dollar exchanged for about 159 pesos. The exchange rate shown in the figure is the official exchange rate at which people in Argentina can legally exchange pesos for dollars. In practice, it is difficult for many individuals and small firms to buy dollars at the official exchange rate. Instead, they have to use private currency traders who will make the exchange at an unofficial—or “blue”—exchange rate that varies with the demand and supply of pesos for dollars. A reporter for the Economist described his experience during a recent trip to Argentina: “Walk down Calle Lavalle or Calle Florida in the centre of Buenos Aires and every 20 metres someone will call out ‘cambio’ (exchange), offering to buy dollars at a rate that is roughly double the official one.” 

People in Argentina are reluctant to deposit their money in banks, partly because the interest rates banks pay typically are lower than the inflation rate, causing the purchasing power of money deposited in banks to decline over time.  People are also afraid that the government might keep them from withdrawing their money, which has happened in the past. As an alternative to depositing their money in banks, many people in Argentina buy more goods than they can immediately use and store them, thereby avoiding future price increases on these goods. The Wall Street Journalquoted a university student as saying: “I came to this market and bought as much toilet paper as I could for the month, more than 20 packs. I try to buy all [the goods] I can because I know that next month it will cost more to buy.”

Devon Zuegel, a U.S. software engineer and economics blogger who travels frequently to Argentina, has observed one unusual way that some people in Argentina save while experiencing hyperinflation:

“Bricks—actual bricks, not stacks of cash—are another common savings mechanism, especially for working-class Argentinians. The value of bricks is fairly stable, and they’re useful to a family building out their house. Argentina doesn’t have a mortgage industry, and thus buying a pallet of bricks each time you get a paycheck is an effective way to pay for your home in installments. (Bricks aren’t fully monetized, in that I don’t think people buy bricks and then sell them later, so people only use this method of saving when they actually have something they want to use the bricks for.)”

Sources: “Sergio Massa Is the Only Thing Standing Between Argentina and Chaos,” economist. com, October 13, 2022;  Devon Zuegel, “Inside Argentina’s Currency Exchange Black Markets,” devonzuegel.com, September 10, 2022; Silvina Frydlewsky and Juan Forero, “Inflation Got You Down? At Least You Don’t Live in Argentina,” Wall Street Journal, April 25, 2022; and Federal Reserve Bank of St. Louis, FRED data set.

Should the Fed Be Looking at the Median CPI?

For years, all the products for sale in Dollar Tree stores had a price of $1.00 or less. But as inflation increased, the company had to raise its maxium prices to $1.25. (Thanks to Lena Buonanno for sending us the photo.)

There are multiple ways to measure inflation. Economists and policymakers use different measures of inflation depending on the use they intend to put the measure of inflation to. For example, as we discuss in Macroeconomics, Chapter 9, Section 9.4 (Economics, Chapter 19, Section 19.4), the Bureau of Labor Statistics (BLS) constructs the consumer price index (CPI) as measure of the cost of living of a typical urban household. So the BLS intends the percentage change in the CPI to measure inflation in the cost of living as experienced by the roughly 93 percent of the population that lives in an urban household. (We are referring here to what the BLS labels CPI–U. As we discuss in this blog post, the BLS also compiles a CPI for urban wage earners and clerical workers (or CPI–W).)

As we discuss in an Apply the Concept in Chapter 15, Section 15.5, because the Fed is charged by Congress with ensuring stability in the general price level, the Fed is interested in a broader measure of inflation than the CPI. So its preferred measure of inflation is the personal consumption expenditures (PCE) price index, which the Bureau of Economic Analysis (BEA) issues monthly. 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. Because the PCE price index includes more goods and services than the CPI, it is suits the Fed’s need for a broader measure of inflation. The Fed uses changes in the PCE to evaluate whether it’s meeting its target of a 2 percent annual inflation rate.

In using either the percentage change in the CPI or the percentage change in the PCE, we are looking at what inflation has been over the previous year. But economists and policymakers are also looking for indications of what inflation may be in the future. Prices of food and energy are particularly volatile, so the BLS issues data on the CPI excluding food and energy prices and the BEA does the same with respect to the PCE. These two measures help avoid the problem that, for example, a period of high gasoline prices might lead the inflation rate to temporarily increase. Note that inflation caclulated by excluding the prices of food and energy is called core inflation.

During the surge in inflation that began in the spring of 2021 and continued into the fall of 2022, some economists noted that supply chain problems and other effects of the pandemic on labor and product markets caused the prices of some goods and services to spike. For example, a shortage of computer chips led to a reduction in the supply of new cars and sharp increases in car prices. As with temporary spikes in prices of energy and food, spikes resulting from supply chain problems and other effects of the pandemic might lead the CPI and PCE—even excluding food and energy prices—to give a misleading measure of the underlying rate of inflation in the economy. 

To correct for this problem, some economists have been more attention to the measure of inflation calculated using the median CPI, which is compiled monthly by economists at the Federal Reserve Bank of Cleveland. The median CPI is calculated by ranking the price changes of every good or service in the index from the largest price change to the smallest price change, and then choosing the price change in the middle. The idea is to eliminate the effect on measured inflation of any short-lived events that cause the prices of some goods and services to be particularly high or particularly low. Economists at the Cleveland Fed have conducted research that shows that, in their words, “the median CPI provides a better signal of the underlying inflation trend than either the all-items CPI or the CPI excluding food and energy. The median CPI is even better at forecasting PCE inflation in the near and longer term than the core PCE price index.”

The following figure shows the three measures of inflation using the CPI for each month since January 2019. The red line shows the unadjusted CPI, the green line shows the CPI excluding food and energy prices, and the blue line shows median CPI. To focus on the inflation rate in a particular month, in this figure we calculate inflation as the percentage change in the index at an annual rate. That is, we calculate the annual inflation rate assuming that the inflation rate in that month continued for a year.

Note that for most of the period since early 2021, during which the inflation rate accelerated, median inflation was well below inflation measured by changes in the unadjusted CPI. That difference reflects some of the distortions in measuring inflation arising from the effects of the pandemic.

But the last two values—for July and August 2022—tell a different story. In those months, inflation measured by changes in the CPI excluding food and energy prices or by changes in median CPI were well above inflation measured by changes in the unadjusted CPI.  In August 2022, the unadjusted CPI shows a low rate of inflation—1.4 percent—whereas the CPI excluding food and energy prices shows an inflation rate of 7.0 percent and the median CPI shows an inflation rate of 9.2 percent. 

We should always be cautious when interpreting any economic data for a period as short as two months. But data for inflation measured by the change in median CPI may be sending a signal that the slowdown in inflation that many economists and policymakers had been predicting would occur in the summer of 2022 isn’t actually occurring. We’ll have to await the release of future data to draw a firmer conclusion.

Sources: Michael S. Derby, “Inflation Data Scrambles Fed Rate Outlook Again,” Wall Street Journal, September 14, 2022; Federal Reserve Bank of Cleveland, “Median CPI,” clevelandfed.org; and Federal Reserve Bank of St. Louis.

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.

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 (PCEprice 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.

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(PCEprice 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. 

Hoover Institution Podcast with Lawrence Summers and John Cochrane

Lawrence Summers (Photo from harvardmagazine.com.)
John Cochrane (Photo from hoover.org.)

In several of our blog posts and podcasts, we’ve discussed Lawrence Summers’s forecasts of inflation. Beginning in February 2021, Summers, an economist at Harvard who served as Treasury secretary in the Clinton administration, argued that the United States was likely to experience rates of inflation that would be higher and persist longer than Federal Reserve policymakers were forecasting. In March 2021, the members of the Fed’s Federal Open Market Committee had an average forecast of inflation of 2.4 percent in 2021, falling to 2.0 percent in 2022. (The FOMC projections can be found here.)

In fact, inflation measured by the CPI has been above 5 percent every month since June 2021; the Fed’s preferred measure of inflation—the percentage change in the price index for personal consumption expenditures—has been above 5 percent every month since October 2021. Summers’s forecasts of inflation have turned out to be more accurate than those of the members of the Federal Open Committee. 

In this podcast, Summers discusses his analysis of inflation with four scholars from the Hoover Institution, including economist John Cochrane. Summers explains why he came to believe in early 2021 that inflation was likely to be much higher than generally expected, how long he believes high rates of inflation will persist, and whether the Fed is likely to be able to achieve a soft landing by bringing inflation back to its 2 percent target without causing a recession. The first half of the podcast, in particular, should be understandable to students who have completed the monetary and fiscal policy chapters (Macroeconomics, Chapters 15 and 16; Economics, Chapters 25 and 26).  Background useful for understanding the podcast discussion of monetary policy during the 1970s can be found in Chapter 17, Sections 17.2 and 17.3.