Inflation occurs when prices rise over time, which reduces the purchasing power of money. It’s important for economies to keep inflation low enough to sustain economic growth and make it easy to do business, but too high and it can be disruptive to an economy. Inflation can occur when demand for a product outstrips supply or when economic growth raises worker wages and those wage increases are passed on to the price of goods and services. When this happens it is called demand-pull inflation. The best way to keep inflation low is to maintain healthy labor markets and economic growth.
The COVID-19 pandemic led to disruptions in the supply chain, which caused shortages of some products and pushed up their prices. In addition, households reduced spending because they feared that the restrictions imposed by the pandemic would be permanent and that they’d need to spend their savings to survive. This combination of factors led to a surge in inflation.
While it’s impossible to say for sure what caused the COVID-19 inflation surge, most researchers agree that it was primarily demand-driven. This is because tight labor markets (measured by the ratio of job vacancies to unemployment) are associated with higher core inflation as workers push for higher wages and those wage gains are passed on to the prices of goods and services.
Inflation expectations, as measured by the University of Michigan Survey of Consumers, also rose during this period. But, the unexplained component of the spike in inflation expectations exceeded the 95 percent confidence interval, suggesting that expectations may have become more de-anchored than usual.