Dyears an article published in June (“What Caused the US Pandemic-Era Inflation? », Working PapersNBER, 2023), Olivier Blanchard, ex-chief economist of the International Monetary Fund (IMF), and Ben Bernanke, ex-governor of the American central bank, return to the galloping inflation that the American economy has experienced. The authors seem to suggest that everyone was ultimately wrong, even those who predicted it.
Although co-authored by one of those (Olivier Blanchard) who correctly predicted the acceleration of inflation, this article argues that the reasons that were invoked then are not those that were finally observed. The cassandras were wrong to be right, in a way. Furthermore, unlike other papers that focus on analyzing or forecasting inflation, this article focuses on the chronology of events: which leads it to conclude that everyone was wrong, but not at the same time time !
Those who thought that inflation would accelerate sharply were right about the end of the story, but not about how it unfolded. Their key idea was that excessive policy support was the root cause of runaway inflation.
According to this scenario, the post-deconfinement rebound in demand would be exaggerated by these support policies, bringing gross domestic product (GDP) to a level well above potential supply. The labor market would then be put to a strong contribution so that supply can meet demand, thus causing pressure on wages, and ultimately maintaining lasting inflation.
Later than expected
But there was a necessary condition for the realization of such a scenario. Wages had to react to the labor market, which no longer seemed to be the case for a few decades. In the language of economists, this assumed that the famous Phillips curve, linking the unemployment rate to inflation, ceases to be flat (“What Is the Phillips Curve (and Why Has It Flattened)”, Federal Reserve Bank of Saint Louis, 2020). In such a scenario, central banks would then have to react by raising their key rates. And that’s what they actually did.
However, demonstrate Olivier Blanchard and Ben Bernanke, the sequence of events invalidates such a scenario. For one reason and one reason only: wages have not reacted as strongly as expected to tensions in the labor market, whether in 2021 or 2022. Afterwards, yes, wages will finally accelerate, but more later than expected.
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