Jack Salmon at “The Unseen and the Unsaid” in “Important Lessons From the 2021-24 Inflation Surge could lead the unwary pupil astray.
Take the subhead,
Demand, not supply, drove the post-pandemic price spike
What does this mean? Inflation is the result of Fed policy. Fed policy may at times be inflating to adjust to a demand shock or to a supply shock or disinflating to return inflation to their target. Supply and demand are not agents.
Just what are the lessons and who are they for?
However, [inflation] wasn’t entirely unforeseen: In early 2021, especially around the time of the enacting of the American Rescue Plan Act (ARPA), some economists did warn that inflation was a real risk.
Inflation to facilitate adjustments of relative prices when the economy has experienced a huge negative supply shock like COVID is not a risk but a response. Was there a risk of more inflation than necessary for adjustment? Yes, but there was also a risk of less inflation than was necessary as we saw that in 2008 and following. What is the “lesson?”
Jason Furman noted that the ARPA was “definitely too big for the moment.”
If these expenditures as well as the Covid relief expenditures in 2020 were greater than the sum of the net present values of the incomes they generated (not a bad guess) then they were indeed too big and required the Fed to have higher interest rates that would otherwise have been necessary to achieve i’s inflation target resulting in lower long-term growth. The federal government has been borrowing to pay for expenditures with negative net present value since the GWB tax cuts in 2001. What is the Lesson?
“ARPA stimulus was two to three times larger than what was needed to close the output gap.”
It is really disappointing to see a supposedly conservative-leaning economist abandon Milton Freidman to use language that implies that Keynesian fiscal policy controls aggregate demand. It’s Fed policy that closes, fails to close, or slams the door on the fingers of an “output gap.” Besides reiterating that fiscal policy should hold borrowing to no more that public investment, what is the lesson?
In the immediate aftermath of the pandemic, as inflation began climbing month after month in 2021, conventional wisdom was quick to settle on an explanation: It was temporary. It was the result of clogged ports, empty factories, and a few container ships idling off the coast of Los Angeles. If policymakers were at fault, it was only for underestimating the fragility of global supply chains. “Transitory” became a kind of rhetorical shield, acknowledging the discomfort of rising prices without assigning real responsibility.
Just so! After the COVID shock, the Fed was wise to create temporarily high inflation to straighten out the kinks in supply chains.
But
As more data became available and as researchers dug deeper into the timeline and mechanics of the inflation surge, the narrative shifted —or rather, it sharpened. The surge in prices was not primarily driven by snarled supply chains or external shocks. It was a story of overheating demand pushing beyond the economy’s productive capacity. And central to that overheating was the sheer scale and timing of fiscal stimulus, especially the ARPA
Indeed, the way for the Fed to push relative prices to adjust so as to overcome the COVID-constrained productive capacity was to engineer over-target inflation. Sorry, but ARPA affected only which combination of instruments the Fed used to create the over-target inflation, greater purchase of USG liabilities and less of others. What is the lesson?
Economists at the Federal Reserve, IMF, NBER, and other institutions have now reached a broad consensus: Demand, not supply, was the dominant driver of U.S. inflation during the pandemic era. A 2024 paper by Kristin Forbes, Jongrim Ha, and M. Ayhan Kose at the Centre for Economic Policy Research finds that nearly 60 percent of the inflation spike between 2020 and 2023 was driven by demand-side forces, including monetary accommodation. Supply shocks, while real, accounted for the remaining 40 percent. A similar study by IMF researchers Melih Firat and Otso Hao puts the split at roughly 50/50 — still a far cry from the “it’s just the supply chain” explanations that once dominated headlines.
It is hard to understand what a division between “supply” and “demand” as a “driver” of inflation means in a model that does not include Fed policy. That only 40-50% of the actual inflation was needed to deal with the supply shock of COVID and the remainder dealt with the demand shock of the shift from services to goods? Or was some of the inflation not necessary at all? Without addressing that question, what is the lesson?
Later Salmon cites a 2025 NBER paper by Robert J. Barro and Francesco Bianchi that
uses a “fiscal dominance” framework to analyze inflation across 37 OECD countries. Their model, based on the idea that inflation can arise when governments fund spending through money creation or implicit debt monetization, finds that the U.S. fits the theory almost perfectly.
“Fiscal dominance” means that the central bank abandons its inflation target to avoid higher interest rates on government debt (or some other “fiscal” reason). As I read the Barro and Bianchi paper, it ultimately boils down in the kitchen of such excellent chefs to showing a relation between government spending and departure of inflation from what would otherwise have been expected. [In their model the US inflation experience is thoroughly typical.]
But the model does not really show causation running from spending to inflation, as Salmon takes it to show. The same shocks that lead a central bank to inflate above target (above trend/expectation in B&B’s model) presumably also lead a government to spend more. [Indeed a “neoclassical” expenditure function in which expenditure is driven by changes in the net present value of activities leads to exactly that fiscal behavior.] Again, what is the lesson?
Here Salmon concludes:
Today, the data is in. The fog of “transitory” inflation has lifted, and the literature tells a coherent story: The U.S. had an overheating problem, and it was self-inflicted. The American Rescue Plan didn’t merely soften the landing from COVID, it inadvertently lit the fuse on the largest inflation surge in four decades.
But there are two problems with this conclusion.
a) It fails to specify what part if any of the inflationary “heating” was “over” and consequently whether the correct verb is “self-inflicted” or “self-administered.”
b) It assumes that the independent variable was ARP rather than supply and demand shocks that led the Fed temporarily to choose above-target inflation rates.
Consequently, we are again left to wonder, what is the lesson.
Happily, there is also a nice section dismissing the empirical basis of “greedflation.”
In sum, the case for greedflation is intellectually thin. It’s based on cherry-picked anecdotes, correlation errors, and populist impulse.
Amen.
Nevertheless, when we do at last get to a lesson:
If there’s a lesson here, it’s that inflation doesn’t require exotic explanations. It can still be caused by printing and spending too much money, too fast. Supply chains can fray, wars can disrupt, and oil prices can spike — but persistent inflation only emerges when those shocks hit an economy already primed to overheat. The responsibility for that overheating lies in Washington. And if we fail to learn that lesson, we shouldn’t be surprised when history repeats itself
We are left with an ambiguity. Agreeing with Salmon that the responsibility for inflation (“overheated” or not) resides in Washington, Is the street address Capitol Hill or 2021 Constitution Ave?
Image: Stern teacher addressing a pupil in a dunce cap. [Apologies to the philosopher Duns Scotus (1265-1308) who was anything but a dunce.
]
[Standard bleg: Although my style is know-it-all-ism, I do not deny that I can be mistaken or overstate my points. I also know there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]
1. You're half right about inflation being a monetary phenomenon à la Friedman. The Fed can counter fiscal deficits with tight monetary policy, as it did in the early 1980s. However, the stimulus still fueled a significant portion of the demand-driven inflation. This New York Fed paper estimates that at least half of the post-pandemic demand-side inflation can be attributed to fiscal stimulus: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr1050.pdf
2. Here's how I would approach countercyclical policy. On the monetary side, implement an NGDP target or Taylor Rule. On the fiscal side, implement a Swiss debt rule, which means that Congress can run deficits during recessions but must run surpluses and reduce debt over the entire business cycle.
3. What are your thoughts on static vs. dynamic scoring? Republicans argue the CBO should account for the pro-growth effects of tax cuts. Democrats respond that the CBO should also include the growth impacts of things like infrastructure spending. Both sides have a point. But in my view, dynamic scoring is difficult to do with precision, and we should be very wary of budget gimmicks. However, the dynamic impact of tax cuts or spending hikes that increase the deficit seems relevant to your NPV fiscal rule.
Thomas, my understanding is that the ‘level’ of spending is important, but so is WHAT it’s spent on. Government spending that increases supply (improved ports, roads, loans for capital assets…) should not cause long term inflation. Can you comment?