The inflation of the last several years has been the most significant macroeconomic development in a generation, and the question of where it goes next has divided the forecasters. The consensus that emerged after the initial shock — that inflation was transitory, then that it would fall quickly once the supply disruptions eased — has been revised repeatedly, and the current outlook is more uncertain than the confident predictions of either direction suggest.
What is clear is that the forces that drove inflation up were multiple, and that they have not all unwound at the same pace. The supply-side disruptions have largely eased; the demand-side pressures have proven more persistent; and the structural forces that were supposed to keep inflation low for the long term have, in some cases, reversed.
The forces that drove it up
The initial surge was widely attributed to supply — the disruptions to shipping, the shortages of components, the energy price spike. These were expected to ease, and they largely have. But inflation did not fall as quickly as the supply explanation predicted, and the persistence pointed to a demand component that was harder to resolve. The fiscal support that sustained demand through the disruption, combined with the monetary accommodation that accompanied it, left households and businesses with the spending power that kept prices rising even as the supply healed.
The labor market has been central to the persistence. Tight labor markets have produced wage growth that, in some sectors, has outpaced productivity, and that wage growth has been passed into prices. Whether this constitutes a wage-price spiral depends on definitions, but the dynamic — higher wages feeding higher prices feeding demands for higher wages — has been visible enough to shape the central-bank response.
The structural forces that reversed
The decades before the surge were characterized by structural forces that kept inflation low: globalization that lowered the cost of goods, demographics that expanded the labor force, and technology that reduced the cost of production and distribution. Each of these forces has, to varying degrees, reversed. Globalization is fragmenting as supply chains are restructured for resilience rather than efficiency; demographics are turning as workforces age and shrink; and the technology story is more mixed, with some forces disinflationary and others, such as the capital intensity of the energy transition, inflationary.
The implication is that the inflation the economy returns to may not be the inflation it left. The low, stable inflation of the pre-surge era was the product of forces that may not return, and the equilibrium that emerges from the current adjustment could be higher than the one forecasters had grown accustomed to. Whether it is materially higher, or only slightly, is the central question, and it is not yet answered.
The outlook that depends on choices
Where inflation settles depends on choices that are still being made. Central banks have raised rates aggressively, and the full effect of those increases has not yet been felt; the question is whether they hold long enough to extinguish the persistence, or ease prematurely and allow it to reassert. Governments face choices about fiscal policy that will either reinforce or offset the monetary tightening. And businesses and households will make decisions about pricing, wages, and spending that will shape the inflation that actually arrives.
The honest assessment is that the outlook is uncertain, and that uncertainty is itself a factor. The inflation expectations that central banks watch so closely are, in part, a reflection of how uncertain the public has become, and uncertainty can become self-fulfilling if it leads to the precautionary behaviors that sustain inflation. The path back to stability runs through the restoration of confidence as much as through the technical adjustment of rates, and that restoration is the harder task.
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