The Great Tightening: Insights from the Recent Inflation Episode

Abstract

The recent global inflationary experience was characterized by a complex set of events. During COVID-19 lockdowns, demand shifted towards goods and then pivoted toward services as economies reopened. These demand shifts occurred in the context of supply disruptions, and unprecedented fiscal and monetary stimulus. Subsequently, of the war in Ukraine led to spikes in commodity prices. Evidence suggests that the pass-through of sectoral price pressures to core inflation and the steepening of the inflation-slack relationship, i.e., the Phillips curve, were essential to understand the global surge in inflation. This evidence is consistent with key sectors hitting their supply bottlenecks, as demand rotated across sectors and was boosted over time by a drawdown of savings. 

This chapter offers a new lesson, and it confirms an old one for monetary policy. In extreme cases when sectoral supply bottlenecks are widespread across the economy and interact with strong demand, inflation can surge but tighter policy can bring it down quickly with limited output costs. Outside of such cases, where supply bottlenecks are confined to specific sectors, conventional policy rules, such as those that target measures of core inflation, perform well.

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