The rate at which prices rise or decline is a key factor in the economy. It can influence purchasing power, slow economic growth, or raise or lower interest rates on debt. Understanding how and why prices change is one of the main challenges for policymakers.
Inflation is often thought of as a negative economic force, but it can also be beneficial. If the prices of goods and services rise at a healthy pace, households’ nominal income (in the form of money) will increase as well. This is known as inflation-adjusted income or real income. If prices do not rise at the same pace as income, households will be worse off because they will have to pay more for things. This is called deflation.
During the coronavirus pandemic, headline inflation rose rapidly in most economies. This rapid movement was caused by a combination of factors that affected different countries to varying degrees. One explanation is that a large increase in prices in commodity markets such as oil, gas or food drove global inflation. Another explanation is that domestic factors such as higher than normal levels of government spending or tight labor markets contributed to the increase in inflation in the COVID-19 pandemic.
This article examines these and other possible reasons for the rapid rise and fall of global inflation during the pandemic. We find that the strength of macroeconomic conditions and changes in longer-term inflation expectations contribute only modestly to explaining the sharp rise and fall of global headline inflation. The more important factor appears to be a rapid movement in energy price inflation and a more gradual shift in core inflation.