In this analysis we offer inflation-related updates to Chapter 1 of Recession Remedies: Lessons Learned from the U.S. Economic Policy Response to COVID-19, which addressed the macroeconomic impact of the breadth of economic policy responses from March 2020 through the American Rescue Plan. On the whole, the array of policies implemented since early 2020 to support the economy were largely successful in buffering households and businesses from the worst potential economic outcomes posed by the downturn. However, the unwelcome and persistent rise in inflation that began in 2021 suggests that consumer demand boosted by fiscal support and strong household balance sheets continue to outpace the capacity of businesses and their global supply chains to expand.
The continued pickup in inflation has led to further declines in real wages in aggregate. Initially, the increase in wages outpaced the increase in prices, and real wages rose (Figure 1). Since mid-2021, however, real wages have been below their pre-pandemic level and have been even further below where they would be if they continued along their pre-pandemic trend. That shortfall was 3.3 percent relative to trend at the end of 2021 and 5.0 percent at the end of the first quarter of 2022. Leisure and hospitality and retail trade are the only two broad industry groups where wages have risen in real terms since the end of 2019, growing at annual rates of 1.4 percent and 0.6 percent, respectively.
Extraordinary price increases in the goods sector were the primary driver of inflation through much of 2021, contributing about two-thirds of the unusual runup in the Consumer Price Index (CPI) for the year. However, more recently, price increases in services have been the main driver. Inflation in core goods (which exclude food and energy commodities) seems to have peaked on a year-over-year basis in March 2022: inflation in core goods declined from 11.7 percent in March to 9.7 percent in April (Figure 2). On the other hand, prices in the service sector have accelerated in recent months. Food and energy prices have pushed headline CPI inflation well above core CPI inflation (8.2 percent and 6.1 percent, respectively, in April), in part reflecting the impact of Russia’s war in Ukraine on energy and other commodities. Energy price inflation has hovered between 25 percent and 33 percent since the middle of 2021. Prices for food increased 9 percent through April, the highest rate since 1981.
Fiscal support for an economy with significant unused capacity increases output and employment with little effect on inflation; but if the economy overshoots its sustainable level, additional fiscal support will feed increasingly into inflation. Going forward, the magnitude and timing of fiscal policy responses to recessions could be improved through better targeting and great reliance on automatic stabilizers.