Understanding Covid-flation

A comprehensive decomposition of the changes in consumer prices since the pandemic began suggests that supply constraints in a handful of sectors are still the main source of the trouble.

After a long absence, 2021 was the year that inflation finally returned to the rich world.

Or was it?

The U.S. Consumer Price Index (CPI) rose more than 7% last year—faster than in any 12-month span since the early 1980s—but most of the excess inflation can be pinned on a handful of categories that account for a small fraction of the total index. If the prices of just a few specific items had grown at their pre-pandemic pace, instead of jumping by 50% or more, inflation in 2021 would have been remarkably close to the 1995-2019 average.

The good news is that what happened last year was the confluence of several distinct forces largely attributable to the extraordinary circumstances of the pandemic. As the public health situation normalizes and the shocks of the past two years fade, so too should the rate of price increases.¹

The pandemic disrupted production in everything from meatpacking to motor vehicles. The threat of Covid also pushed consumers to alter their spending patterns. People the world over slashed their spending on services such as dental cleanings, college, and nights on the town. At the same time, consumers spent more than ever before on groceries, appliances, furniture, cars, exercise equipment, and housing—financed in part by the more than $10 trillion that governments disbursed to offset the impact of the pandemic on household incomes and corporate balance sheets.²

Disentangling the relative importance of these forces on overall inflation isn’t straightforward. My approach has been to look at how each of the components in the CPI has contributed to changes in the level of the overall index each month. In the chart below, for example, the blue bars represent price increases attributable to temporary pressures on specific sectors associated with the pandemic and economic reopening, while the smaller red bars represent the rest of the economy.

With the exception of energy prices, the data from December weren’t meaningfully different from October or November.³ In fact, there has been little change in the height of the red bars ever since inflation began picking up in April, even though the overall monthly inflation rate has been far more volatile.

Since I don’t want to bore you (or myself) by simply recapitulating the same analysis with slightly updated charts, this note will feature a new set of decompositions, a longer time horizon, and an investigation of the cumulative inflationary contributions of each component. My conclusions haven’t changed, but I believe the additional visualizations and breakdowns are helpful for understanding the issues at hand.

Micro or Macro?