Working Paper: CEPR ID: DP16328
Authors: Jongrim Ha; M. Ayhan Kose; Franziska Ohnsorge
Abstract: We analyze the evolution and drivers of inflation during the pandemic and the likely trajectory of inflation in the near-term using an event study of inflation around global recessions and a factor-augmented vector auto-regression (FAVAR) model. We report three main results. First, the decline in global inflation during the 2020 global recession was the most muted and shortest-lived of any of the five global recessions over the past 50 years and the increase in inflation since May 2020 has been the fastest. Second, the decline in global inflation from January-May 2020 was four-fifths driven by the collapse in global demand and another one-fifth driven by plunging oil prices, with some offsetting inflationary pressures from supply disruptions. The subsequent surge in inflation has been mostly driven by a sharp increase in global demand. Third, both model-based forecasts and current inflation expectations point to an increase in inflation for 2021 of just over 1 percentage point. For virtually all advanced economies and one-half of inflation-targeting emerging market and developing economies (EMDEs), an increase of this magnitude would leave inflation within target ranges. If the increase is temporary and inflation expectations remain well-anchored, it may not warrant a monetary policy response. If, however, inflation expectations risk becoming unanchored, EMDE central banks may be compelled to tighten monetary policy before the recovery is fully entrenched.
Keywords: global inflation; COVID-19; global recession; FAVAR; oil prices; global shocks
JEL Codes: E31; E32; Q43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| positive global demand shock (F69) | increase in global output growth (F62) |
| positive global demand shock (F69) | increase in global inflation (F69) |
| positive global demand shock (F69) | increase in oil price growth (Q43) |
| positive global supply shock (F41) | increase in global output growth (F62) |
| positive global supply shock (F41) | increase in oil price growth (Q43) |
| positive global supply shock (F41) | decrease in global inflation (E31) |
| collapse in global demand (F69) | decline in global inflation during the 2020 global recession (E31) |
| plunging oil prices (Q31) | decline in global inflation during the 2020 global recession (E31) |
| sharp rebound in global demand (F69) | surge in inflation post-recession (E31) |
| increase in inflation expectations (E31) | potential necessity for monetary policy response (E49) |
| risk of unanchored inflation expectations (E31) | compel EMDE central banks to tighten monetary policy prematurely (E52) |