How much of the inflation is excessive?

[If you only read one post today, read my new Econlog post. I regard it as the most important post I’ll do this year.]

I am amused when I see people debating whether the current inflation is supply or demand driven, as if this is some sort of factual question.

To a hard-core inflation hawk that favors of policy of 2% inflation come hell or high water, all excessive inflation is demand driven, by definition.

In contrast, let’s say you favor 5.5% NGDP growth because you want an inflation rate high enough to keep us out of a liquidity trap. (Recall those economists who wanted to raise the inflation target to 4%.) If 5.5% NGDP growth is the baseline, then nominal spending growth since late 2019 has been roughly appropriate, and all of the current high inflation is supply driven.

When people debate whether inflation is caused by supply or demand factors they believe they are debating something about the nature of the universe, whereas they are actually debating what sort of monetary policy would have been appropriate over the past 2 years.

When I started blogging in early 2009, I assumed a trend rate of NGDP growth of roughly 5%, representing 2% inflation and 3% RGDP growth. But then the trend rate of RGDP growth began slowing, mostly due to slower population growth, but also slower productivity growth. Because the Fed insists on a 2% inflation target, I began suggesting a 4% NGDP growth figure as being roughly consistent with the Fed’s policy preferences.

But even 4% may now be too high. RGDP growth over the past 15 years has averaged only 1.63%, despite a falling unemployment rate. Even worse, population growth has plummeted during that period, so the next 15 years are likely to be even slower. If the Fed is serious about 2% inflation (and I’m having my doubts) then 3.5% NGDP growth is the baseline to evaluate monetary policy.

On the other hand, under their current asymmetric FAIT policy it seems like they are correcting inflation undershoots but not overshoots, implying more than 2% inflation on average. So let’s just stay with 4% NGDP growth as roughly representing the Fed’s dual mandate of 2% inflation (with occasional overshoots) and 1.5% RGDP growth.

Since the 4th quarter of 2019, NGDP growth has averaged about 5.26%, pushing the level roughly 3% above trend over the past 2 1/4 years (or even more if you use the 3.5% trend line benchmark.) So a significant portion of the inflation is demand driven.

The Fed’s preferred PCE price index has averaged 4% inflation since January 2020. So there’s a total of roughly 5% excess inflation over the past 2 1/4 years. From my perspective, it makes sense to view the recent higher than normal inflation as being roughly half supply driven and half demand driven, with the caveat that the overshooting (of both NGDP and PCE) will get even worse over the next 6 months.



24 Responses to “How much of the inflation is excessive?”

  1. Gravatar of Michael Sandifer Michael Sandifer
    5. June 2022 at 13:06

    I would just take issue with one point here, as the other numbers are pretty much dead on. Mean RGDP growth from the beginning of 2010 through 2019 was 2.23%. If we start at 2013 an go through 2019, the mean is even higher. I would think these would be better baselines than the ones you offer, which includes the Great Recession.

    And yes, right now forward indicators, as I interpret them, seem to have the expected mean RGDP growth path at about 1.5%, but it is possible that supply-side factors are expected to last longer than most economists anticipate, while ulitmately still being temporary. Perhaps this helps explain the Dollar’s increasing forex strength, though other plausible explanations exist, such as relative fiscal profligacy(particularly to the degree Republicans are expected to control the federal government).

    That said, even if the entire run up of the Dollar is due to relatively higher RGDP growth expectations, we’re talking about a difference of at most, maybe 0.2% in terms of annual RGDP growth. And that assumes a higher mean RGDP growth rate than you anticipate.

    Also, it’s fair to say I probably shouldn’t care about baselines much if my own models of forward indicators agrees with you more than the past data. Market expectations rule. While the interpretation that agrees with you seems the most plausible to me, it isn’t the only possible one.

  2. Gravatar of Larry Larry
    5. June 2022 at 13:31

    All of your arguments have to do with the US economy.

    You do not talk about the global economy.

    But what we have seen in the last couple of years is how interdependent the world economies have become. But you ignore this.

    What is apparently also happening is that the US currency which has been the the world reserve currency will no longer have that role in the near future.

    So how do you think these changes will impact the US economy?

    As far as I am concerned there are bad times a coming.

  3. Gravatar of msgkings msgkings
    5. June 2022 at 13:53


    “near future”…

    What are you talking about?

  4. Gravatar of marcus nunes marcus nunes
    5. June 2022 at 14:16

    The post linked below provides a “stage by stage” evaluation of monetary policy during the pandemic-induced crisis. One of the benefits of the analysis is that we can identify the nature of inflation and the exact moment when the Fed “went overboard”.

  5. Gravatar of ssumner ssumner
    5. June 2022 at 14:29

    Michael, When considering long run trend RGDP growth, you never want to consider just the expansion phase of the business cycle. The unemployment rate during that period fell from 10% to 3.5%, which is not sustainable.

    You need to look over multiple cycles, which is what I did.

  6. Gravatar of Michael Sandifer Michael Sandifer
    5. June 2022 at 17:24


    I gratefully accept your correction on the choice of baselines.

    And, as I mentioned, forward-looking data is always preferred anyway, and to my chagrin, it seems to agree with you on future expected mean RGDP growth.

  7. Gravatar of Michael Sandifer Michael Sandifer
    5. June 2022 at 17:54


    I really like how one of your charts in your post linked to above shows the US economic growth falling below trend in 2006.

    Generally, I don’t know why people decouple the supply shocks, which began in about 2002 and grew pretty steadily worse for years, with the productivity slowdown that began to show in 2004. Then, beginning in 2006, productivity growth began to be further drained by tight monetary policy. This is one of the reasons I still suspect that potential RGDP growth is higher than commonly thought.

    And, as stated previously, I think it takes economies longer to heal from shocks such as the Great Recession than most seem to think. I think Reinhart and Rogoff’s research demonstrates this pretty clearly.

    Some have pointed out to me that productivity growth was realtively high during the Great Depression, so why should one believe the much shallower depression after the Great Recession drained productivity growth? Well, it seems that industrial electrification very much continued to make industry more efficient in the 30s, for example.

    I think AI will have even more profound effects than electrification as a general source of productivity growth, but we’re in the very early stages of the development of the technology.

  8. Gravatar of Garrett Garrett
    6. June 2022 at 06:24

    Slightly off-topic, just spent a few minutes googling statistics. For 2020 the world population was 7.9bn and world GDP was 84.75tn. US pop was 329.5mm and GDP was 20.94tn. So World GDP/capita was $10,728 and US was $63,551.

    So even if world population stabilized and US GDP/capita didn’t grow, there’d still be 492% of potential global real GDP growth just to get everyone else to the US income level. If that took 100 years that’s 1.79% annual real growth.

    Do these numbers make sense? If so, would US real incomes rise as global real incomes rise even if US technology doesn’t improve just by virtue of better allocative efficiency and economies of scale? By how much? Just trying to get a sense of what the floor RGDP growth expectation should be for the US.

  9. Gravatar of MSS1914 MSS1914
    6. June 2022 at 07:18


    Nice post (and nice article at EconLog), but if the Fed is truly not targeting a 2% inflation average, then someone should tell them to update their website:

    I’ll quote the the last two sentences from that link:
    “To address this challenge, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation modestly above 2 percent for some time. By seeking inflation that averages 2 percent over time, the FOMC will help to ensure longer-run inflation expectations remain well anchored at 2 percent.”

    I’m not an economist, but I have read that paragraph 3 times now and I can’t read it as anything other than a true 2% target, not as a floor of 2%.

    Also, the link says this:
    “The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability.”

    I assume that “judges” means they did a lot of research and empirically determined that the 2% target is optimal. Did they get new data suggesting otherwise and that’s why they are allowing inflation to average higher than 2%? Or, was the inflation target largely arbitrarily chosen and has now been arbitrarily changed? If so, why?

    I have a crazy conspiracy theory: When I see someone or something behaving seemingly irrational or baffling, I try to remind myself that they might actually be behaving rational in trying to achieve their goals. Goals which I may not fully know. In trying to interpret how the Fed’s recent actions could be interpreted rationally, I find myself thinking that the Fed must publicly pay lip service to the 2% average because their research and past statements claim that it is best for obtaining its dual mandate. But they also have a secret and unspoken third mandate: Don’t spook the asset markets too much. This would explain why they publicly stand by 2% inflation targeting, but actually are hesitant to bring about an economic slowdown. Its crazy and I’m certainly wrong, but I can’t convince myself that I’m 100% wrong.

  10. Gravatar of ssumner ssumner
    6. June 2022 at 07:58

    Michael, You said:

    “I think Reinhart and Rogoff’s research demonstrates this pretty clearly.”

    I seem to recall that Michael Bordo has refuted that research.

    Garrett, I suspect the world GDP figures would be higher on a PPP basis.

    I don’t have much to say about growth prospects, but I think it’s clear that US technology will improve over time, so I don’t see much value in looking at the case where it doesn’t improve. But yes, you’d get some growth merely by better exploiting current technology.

    I also believe that we don’t know how to measure growth. What exactly are we measuring? Utility? Tons of stuff? What?

    We can measure NGDP. But RGDP? How do we measure it?

    MSS1914, Pundits spent the 2010s spinning theories of how the Fed secretly wanted below 2% inflation. They are spending the 2020s spinning theories of how the Fed secretly wants above 2% inflation. I just don’t see much value in that sort of exercise.

  11. Gravatar of Michael Sandifer Michael Sandifer
    6. June 2022 at 08:34


    Bordo doesn’t seem as clear as you seem to indicate. For example, I quote below from page 18 of his paper found here:

    “Recessions that accompany a financial crisis tend to be long and severe (Bordo and Haubrich, 2010, Reinhart and Rogoff, 2009). What that portends for economic growth once a recovery has started is less certain, however. On the one hand, there is the feeling that “growth is sometimes quite modest in the after-math as the financial system resets.” (Reinhart and Rogoff, p. 235).

    On the other hand, there is the stylized fact behind Friedman’s plucking model, that “A large contraction in output tends to be followed on the average by a large business expansion,” (Friedman, 1969, p. 273). One popular measure, the time required to return output to the pre-crisis level, confounds the depth of the recession with the
    strength of recovery. For many purposes, it is important to separate the notions of contraction depth and recovery strength.
    Where does that leave the current recovery? It remains an outlier, as one of the few cases where output did not return to the level of the previous peak after the duration of the recession.

    In this it resembled two very different recessions, the
    Great Depression and 1990. Significantly, both of those combined financial problems and (real) housing price declines, albeit of strikingly different magnitudes.

    The unanswered question, of course, relates to causality–tracing out the exact shocks, and their transmission, remains key. Must housing recover for the recovery to take off, or will the economy pull the industry along? These are questions for another day.”

    I don’t even buy the notion that recessions following financial crises need be particularly weak. I disagree with R&R there. But, just empirically, I think they demonstrate that, in the context of insufficient stimulus, recoveries after recessions can take longer than most economists seem to acknowledge.

    I’m referring to this short paper by R&R:

    Also, I now take my macro interpretation of S&P 500 changes very seriously, so I also take very seriously stock market reactions that are incompatible with an economy at or near equilibrium. If stock prices rise more than the mean expected NGDP growth path suggests in a given year, absent sufficient positive real shocks, it indicates the economy is in recovery mode.

    Yes, factors specific to stock prices sometimes affect the S&P 500 index, such as proposed changes dividend or capital gains taxes, but such factors are relatively rare and easy to account for. They move the S&P 500 level down, but affect the slope of the growth path much less, if at all.

    Yes, the growth path imputed in stock prices means there is temporal discounting, so that’s a disadvantage versus NGDP futures. But, I’ve never denied that a sufficiently liquid NGDP futures market would be superior to targeting the S&P 500.

    However, an NGDP level targeting regime using the S&P 500 would be appreciably better than FAIT+, or even a simple, symmetric FAIT.

    I hope you will reconsider your perspective in the light of that final point there, and realize that it could be a step toward the Fed adopting NGDP level targeting, after which, perhaps, the Fed will opt to create a subsidized NGDP futures market to improve the NGDP targeting further.

  12. Gravatar of ssumner ssumner
    6. June 2022 at 08:45

    Michael, Bordo says:

    “Do steep recoveries follow deep recessions? Does it matter if a credit crunch or banking panic accompanies the recession? Moreover does it matter if the recession is associated with a housing bust? We look at the American historical experience in an attempt to answer these questions. The answers depend on the definition of a financial crisis and on how much of the recovery is considered. But in general recessions associated with financial crises are generally followed by rapid recoveries.”

    That’s in sharp contrast to R&R. And the ones with fast recoveries tended to occur in the period before the federal government had any sort of stimulus programs.

  13. Gravatar of Michael Sandifer Michael Sandifer
    6. June 2022 at 09:30


    2 points:

    1. We should not miss the fact that even the R&R paper understates the length of recovery for economies, given that they focus on trough to the previous RGDP/capita peak. I would think a full recovery would often mean return to the pre-crisis growth trendline. Obviously, there are exceptions, such as Japan, which had oncoming secular stagnation anyway, but this sort of secular stagnation is pretty new in the context of world history.

    2. We can focus solely on the US, but R&R look at 100 international examples, some of which are more relevant than others, granted.

    I must admit somewhat of a bias against looking too far back into the gold standard era, as it might take considerable commitment on my part to understand all of the important differences in how the monetary systems worked then versus now. People like you or George Selgin, for example, in addition to knowing far more about economics than me overall, have a much greater advantage in gold standard era economics, having each studied it far more than even most macroeconomists.

  14. Gravatar of Michael Sandifer Michael Sandifer
    6. June 2022 at 09:39

    On using the S&P 500 to establish an NGDP level target, I’d like to mention something that may not be immediately obvious. It’s against my personal financial interests for monetary policy to improve, or perhaps, to even discuss my perspective publicly in much detail. The stock portfolio stress-testing technology based on my model is impressive enough on its own, and has garnered more than enough attention at this point. If the Fed ever competently adopts NGDP level targeting, such products and services are obsolete.

    However, I’ve never been more concerned about the fate of the US and broader world. There are many problems in the US right now, and the last thing we need is more macro instability. Besides, when trillions of dollars in foregone output and many millions of peoples’ jobs often on the line, what else can I do but whatever I can with what I have to offer?

  15. Gravatar of foosion foosion
    6. June 2022 at 11:28

    Maybe they intended the averaging to start some time ago.  If you use Jan 1, 2007 as the start date, inflation has been running at about 2.4%.  CPI 203 to 288. PCE is presumably closer to 2%.

    Employment has recovered a lot faster than it did following the great recession, which seems a good thing.

  16. Gravatar of David S David S
    6. June 2022 at 13:19

    Having experienced the deflationary hell of the Great Recession I’m waiting to see how our current inflationary hell plays out. So far, I’m doing better now than I was then–albeit annoyed by the price of food, gas, and framing lumber.

    If I’ve been paying attention to Scott’s recent arguments, the failure of the Fed to stick to a credible policy doesn’t bode well for the next few years. Because they ran loose for too long in ’21 they could easily run too tight for too long in ’23 or ’24. History repeating as farce…speaking of which, I thought I was hallucinating when I just read in Vox that Biden was going to “pivot to deficit reduction” to tame inflation. That was a spectacular policy move in 2009, although the rationale was a bit different (and just as nuts) back then.

  17. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. June 2022 at 06:27

    re: “RGDP growth began slowing, mostly due to slower population growth, but also slower productivity growth”

    No. This explains it:

    Banks don’t lend deposits. Deposits are the result of lending.

    see: “Commercial Banks and Financial Intermediaries: Fallacies and Policy Implications–A Comment Leland J. Pritchard Journal of Political Economy
    Vol. 68, No. 5 (Oct., 1960), pp. 518-522

    “The case against commercial bank saving accounts”
    Leland James Pritchard 1964 Banker’s magazine

    “The economics of the commercial bank : savings-investment process in the United States” Leland James Pritchard 1969

    “Should Commercial Banks Accept Savings Deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.

    “Profit or Loss from Time Deposit Banking”, Banking and Monetary Studies, Comptroller of the Currency, United States Treasury Department, Irwin, 1963, pp. 369-386

    Link: The riddle of money, finally solved BY Dr. PHILIP GEORGE

  18. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. June 2022 at 06:42

    Re: “I am amused when I see people debating whether the current inflation is supply or demand driven”

    Semantics. That’s in violation of the inelasticity of demand for oil.

  19. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. June 2022 at 06:47

    @marcus nunes: Great writeup.

  20. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. June 2022 at 08:19

    The GFC spawned a “flight to safety”. And it was encouraged by the FDIC raising deposit insurance to unlimited from $100,000. The reduction to $250,000 released savings. That’s what caused the “Taper Tantrum”. That’s what accelerated the drop in the unemployment rate from 8.0% to 5.0% by Dec. 2015.

    Whereas the 1966 Interest Rate Adjustment Act created a .50% interest rate differential in favor of the Savings and Loan Associations (the thrifts, the nonbanks), the Emergency Economic Stabilization Act of 2008 provided a preferential interest rate differential in favor of the commercial banks (paying interest on reserve balances), which induced nonbank disintermediation.

  21. Gravatar of ssumner ssumner
    7. June 2022 at 08:28

    Foosion, It’s very unlikely they intended that, and it would be a horrible idea. Their inflation forecasts were not consistent with that starting date.

  22. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. June 2022 at 12:00

    In the demand schedule of all products and services, there is an elastic segment. At some level, an increase in price reduces total revenue, and vice versa. If, during the 1973 upward spiral of oil prices, M*Vt had not increased, there would have been a massive diversion of purchasing power from non-petroleum products. The whole country would have experienced, in varying degrees, the depression that afflicted the automotive industry.

    To say, therefore, that falling oil prices will bring down prices and interest rates, and that rising oil prices are inflationary and will increase interest rates, is to ignore the fact that inflation is primarily a monetary phenomenon.

  23. Gravatar of foosion foosion
    7. June 2022 at 16:03

    Scott, that was playing with numbers rather than anything serious.

    But if you’re going to make policy mistakes, I’d rather have the current low unemployment rather than the prolonged high unemployment following the great recession.

    Do you have an estimate of an appropriate unemployment rate, since it’s part of the Fed’s mandate? Or is maximum employment whatever comes from NGDPLT?

  24. Gravatar of ssumner ssumner
    8. June 2022 at 07:57

    Foosion, You asked:

    “Or is maximum employment whatever comes from NGDPLT?”


    “But if you’re going to make policy mistakes”

    But why make either mistake?

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