The debate over what caused the 2021-2022 inflation spike has arisen again because of the presidential election, recent research, and a Washington Post Op Ed by Peter Orszag. As inflation is seen as a primary factor in the election results, its original cause is being relitigated. As more data have become available, it has become more obvious what the string of events that led to inflation were, even though there's still a robust debate over whether it was caused by a supply crunch or the Biden stimulus.
I wrote about this in May of 2023, and my fundamental beliefs haven't changed since then, but I have developed those thoughts even further. I'm also gratified to see that the recent research backs up my interpretation.
What's discouraging to me, is the number of people, including prominent ones who are still drawing conclusions based on the indisputable occurrence of a supply crunch without realizing that nothing can be discerned from a supply crunch because it is impossible to know whether it was caused by problems with manufacturing or because demand outpaced the supply.
If you've ever gone to a grocery store, and seen an empty shelf, do you conclude that the manufacturer had a problem producing that item or that other shoppers must really want it? There's no way to know, right? The same is true post-pandemic: the lack of microchips and cars could be caused by factories that shut down in China, by cargo ships that weren't shipping, or by a level of demand that overwhelmed the factories and shipping.
Three Possible Explanations
The way I see it, there are three potential explanations: the demand explanation, the supply explanation, and the monetary explanation. Note that these explanations can overlap. The prevailing opinion of partisans of the left is the supply-induced explanation. This is that there was a supply crunch caused by a glut of unemployed people and factory closures in the US and abroad because of the pandemic. As a result, the production of goods and the provision of services both fell, and the demand for those goods and services remained the same so prices increased.
It starts with the supply being constrained and the supply curve shifting left. Why does it start with this? What caused it? The cause of this is suggested to be people no longer working during the pandemic, either because they were protecting their health or because the factories and workplaces were closed. This would be true both in the US and abroad, which meant less production of goods and services.
This explanation was never very persuasive to me. The stories about factories in the US and abroad were mostly anecdotal. I never saw any data showing substantial factory closings. On employment, by mid-2021, when inflation began to pick up, total employment was 96% of what it was just before the pandemic started. Unemployment in the US was below 6%. You could perhaps make an argument that as small as these numbers seem, they'd be enough to constrain supply and raise prices. The only problem with that argument is that in prior recessions, unemployment was even higher yet it didn't trigger massive inflation.
The other problem with the supply-first explanation is that a supply crunch would cause prices to go up and quantities to fall. It's taken for granted that the number of items purchased fell because there were shortages, but in fact, the volumes of goods purchased went up during this time.
The events that mattered: Stimulus, the end of the pandemic, the supply "crunch", inflation Savings, spending, The Chain of events: 1. Stimulus Passed. 2. Vaccines 3. Demand ticked up. 4. Inflation ticked up. 5. Freight Ticked up. 6. Inflation So what caused what? Stimulus and pandemic ending led to a rise in demand. The rise in demand encountered a limit in supply. So what caused inflation? Well, an argument can be made that both caused inflation because you can't have a rise in prices without. In fact, what the supply crunchers are saying is that the Supply Curve didn't move enough to lower prices. What about the monetary dimension? PY = MV The federal reserve accommodated the stimulus. Maybe that's what caused inflation. Links https://www.nber.org/papers/w32859 https://www.brookings.edu/articles/covid-19-inflation-was-a-supply-shock/ https://www.realclearmarkets.com/2024/11/19/peter_orszag_discredits_keynesand_supply-side_on_inflation_1073056.html https://www.economicforces.xyz/p/most-inflation-stories-dont-add-up