As many countries struggled to cope with the COVID-19 pandemic and Russia’s unprovoked invasion of Ukraine, they experienced inflation that was unprecedented in a generation. Inflation surged across the globe, eroded cash savings and made it harder for families to reach their financial goals. The surge was the result of a complex series of events, including disruptions to global supply chains and the COVID-19 pandemic’s effect on demand for core goods and services. The large fiscal packages and monetary stimulus provided by central banks around the world also contributed to inflation.
Economists generally divide the causes of inflation into two categories: demand-pull and cost-push. The former reflects price increases driven by consumer demand, while the latter involves rising production costs that are passed on to consumers, such as higher wages or raw materials prices. The inflation surge of 2021 and 2022 involved both, from war-related commodity and supply chain shocks to kinks in the reopening of contact-intensive service sectors.
Models can help strengthen our understanding of the inflation surge and its causes, as well as assess whether different monetary policy responses might have reduced its magnitude. But in the end, policymakers’ ability to reduce inflation depends on a complex mix of trade-offs and compromises between various stakeholders—including businesses that need to raise prices for profit, central banks that need to avoid hindering a fragile economy, and governments that need to balance fiscal support for their citizens with prudent monetary control.
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