Inflation surge is a sudden rise in prices across the economy. It is caused by a combination of factors that include increased consumer demand, reduced production and shipping delays and labor shortages. Firms will price their goods accordingly to maximize profits and attract customers.
In the past, inflation was kept in check by central banks and governments. They used monetary policy and fiscal stimulus to control inflation, keeping the unemployment rate low, and thus minimizing economic pain. The COVID-19 pandemic, however, changed the rules of the game. As lockdowns and shelter-in-place restrictions eased, consumers began to spend again. Companies, meanwhile, experienced decreased shipping and manufacturing capacity due to pandemic-related supply constraints.
As a result, the global supply chain became constrained and shortages of essential goods developed. The increase in demand for those products drove up prices and unemployment. Many economists believe that the COVID-19 pandemic caused a “demand-driven” inflation surge. They believe that the increase in prices would be temporary, as companies resupplied and consumers regained confidence in the availability of essential goods.
However, this theory is not consistent with the observed data. As the data show, most of the increase in inflation was caused by developments that directly raised prices, such as global commodity price shocks and sectoral supply disruptions. Additionally, according to an analysis of impulse responses — a method that decomposes inflation into demand-driven and cost-push components — oil price shocks, and to a lesser extent global supply shocks, have been the most important drivers of variation in global inflation over the past five decades. In contrast, the contributions of global demand shocks and interest rate shocks have diminished.
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