However one does the analysis, the result is the same: the decline in inflation over the past year was largely the predictable (and predicted) consequence of the removal of temporary sources of inflationary pressure. Standard economic models appear to work, after all.
CAMBRIDGE – In just one year, inflation in the United States has fallen from a peak of about 9% to just 3%. Standard economic models suggest that such rapid disinflation would be possible only with a large increase in unemployment. But the unemployment rate has remained steady, at around its 50-year low, for the entire period. Do economists need to throw out our models and start over?
While no macroeconomic theory is perfect, and humility is always in order, a closer look at the data suggests this would be an overreaction. For starters, underlying inflation has fallen by only about one percentage point – much less than the six-percentage-point decline in headline inflation. Moreover, this has happened while labor markets – understood broadly – have loosened considerably, although in a relatively benign manner, with job openings falling instead of unemployment rising.
Underlying inflation is the rate of inflation that would prevail if labor-market tightness remained unchanged. The concept is easier to define than to quantify, but a range of indicators can help us to formulate plausible guesses of its level. In June 2022, when the headline inflation rate peaked at 9%, my rough estimate was that the underlying inflation rate was around 4-4.5%, which is to say that absent any weakening in labor markets, the inflation rate could have been expected to decline by about half. While others may have made somewhat different estimates, no credible economist expected inflation to stay at 9% or higher.
CAMBRIDGE – In just one year, inflation in the United States has fallen from a peak of about 9% to just 3%. Standard economic models suggest that such rapid disinflation would be possible only with a large increase in unemployment. But the unemployment rate has remained steady, at around its 50-year low, for the entire period. Do economists need to throw out our models and start over?
While no macroeconomic theory is perfect, and humility is always in order, a closer look at the data suggests this would be an overreaction. For starters, underlying inflation has fallen by only about one percentage point – much less than the six-percentage-point decline in headline inflation. Moreover, this has happened while labor markets – understood broadly – have loosened considerably, although in a relatively benign manner, with job openings falling instead of unemployment rising.
Underlying inflation is the rate of inflation that would prevail if labor-market tightness remained unchanged. The concept is easier to define than to quantify, but a range of indicators can help us to formulate plausible guesses of its level. In June 2022, when the headline inflation rate peaked at 9%, my rough estimate was that the underlying inflation rate was around 4-4.5%, which is to say that absent any weakening in labor markets, the inflation rate could have been expected to decline by about half. While others may have made somewhat different estimates, no credible economist expected inflation to stay at 9% or higher.