Today’s inflation is driven largely by supply-side constraints, which call for supply-side solutions.
In the decades since the 1970s oil-price shocks sent inflation soaring and shackled economic growth, price stability was maintained even when growth was robust. Many policymakers and economists took a bow, proudly claiming that they had found the magic formula.
Moreover, the sharp growth in corporate profits suggests that increased market concentration may be an important factor in the current inflation. Though the precise causes of higher corporate profits are not entirely clear, there is no dispute that they have indeed risen during the pandemic.
It is also important to recognize that this development runs completely counter to the standard Phillips curve models, which assume an inverse relationship between inflation and unemployment over the short term. The slowing of wage growth has occurred at a time when the unemployment rate is under 4% – a level below anyone’s estimates of the “non-accelerating inflation rate of unemployment.
This example points to a larger issue, because many of the key dimensions of today’s inflation, such as food, housing, energy, and car prices, are likely to respond only to moderately higher interest rates. For example, purchase mortgage applications have already fallen by more than 20% from their levels a year ago, and reductions in house-listing prices have become widespread.
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