BY JASON FURMAN

Commentators have generally offered two arguments about advanced economies’ performance since COVID-19 struck, only one of which can be true. The first is that the economic rebound has been surprisingly rapid, outpacing what forecasters expected and setting this recovery apart from the aftermath of previous recessions.

The second argument is that inflation has reached its recent heights because of unexpected supply-side developments, including supply-chain issues like semiconductor shortages, an unexpectedly persistent shift from services to goods consumption, a lag in people’s return to the workforce, and the persistence of the virus.

The first argument is more likely to be true than the second. Strong real (inflation-adjusted) GDP growth suggests that economic activity has not been significantly hampered by supply issues, and that the recent inflation is mostly driven by demand. Moreover, there is reason to expect demand to remain very strong, which means that inflation will persist.

To be sure, inflationary pressures reflect both supply and demand factors, the exact combination of which is unknowable. But when considering the economy as a whole, it is implausible that all the individual supply stories would add up to the generalized inflation we have seen. It is far more likely that the increase in demand exceeds what the economy can produce, leading to higher prices.

By definition, price growth equals the growth of nominal output minus the growth of real output (with a small difference due to compounding). Over the course of 2021, US real GDP grew by 5.5%, nominal GDP grew by around 11.5%, and GDP price growth thus came in at around 5.9%. For the OECD as a whole, real GDP growth was slightly lower, at 4.9%, and nominal GDP growth was 10.4%, yielding 5.2% GDP price inflation.

Recall that policymakers largely protected or increased disposable personal income at a time when consumption possibilities were constrained (through most of 2020). If one considers these excess savings alongside the persistence of low interest rates through most of 2021, a rising stock market, pent-up demand, and additional fiscal support, the magnitude of the increase in nominal GDP is not particularly surprising. In the United States, discretionary fiscal stimulus totaled $2 trillion in the 2021 calendar year, but nominal GDP was only $1.6 trillion higher than it was in 2019. If anything, the surprise is that nominal spending was so constrained, and that saving rates remained so elevated.

What about real GDP? Here, we need to remember that all the supply-side stories are different ways of saying that real output was constrained. According to one common story, consumption shifted from services to goods, and, because goods production is less responsive to market changes (more “inelastic”), it could not expand quickly enough. Another story is that labor supply was constrained by the pandemic and the policy response (owing to weaknesses in labor supply in the US, and to reductions in hours worked in Europe). And still other stories focus on particular markets, like the reduction in microchip production or the snarling of US ports.

The problem with these accounts is not that they are false; it is that they miss the most important story in economies that have also experienced surprisingly strong real GDP growth. Major economies have enjoyed faster recoveries than they did in the wake of the global financial crisis. In fact, the recovery in most countries was more V-shaped than anything we have seen in decades. Growth in 2021 greatly outpaced what forecasters had expected at the end of 2020, when forecasters were already optimistic about COVID-19 being eliminated.

Overall, the US economy grew 1.6% annually from the end of 2019 to the end of 2021, which is only slightly lower than previous estimates of the economy’s potential. That is an amazing accomplishment considering all the headwinds that have reduced potential GDP: lower immigration, premature deaths, reduced capital formation, and the hysteresis associated with high unemployment.

The point is not that there are no supply-chain issues. Ships really have piled up at ports, and manufacturers really are holding up production for lack of microchips. But this is not necessarily evidence of an adverse change in supply. If we gave every household millions of dollars, that, too, would lead to pileups at ports and overloaded manufacturers. The fact that quantities are up so much – judging by the volume at ports and the level of global microchip production, not to mention the real GDP figures – suggests that our problem is not mainly reduced supply but increased demand.


Looking ahead, there are some reasons to expect demand to cool, but these will need to be weighed in the balance. Fiscal support is indeed winding down everywhere. Interest rates are starting to rise in the US and the United Kingdom, and will increase later this year in Europe as well. And equity markets have recently fallen back sharply.

But households still have substantial excess savings, and the overall stance of monetary policy remains accommodative, suggesting that demand will continue to be strong. Moreover, with Russia’s war in Ukraine, there is now a genuinely large supply shock boosting inflation in the form of higher oil and gas prices (especially in Europe). Combine that with the increase in short-run inflationary expectations, and we should expect high inflation to stay with us for some time.

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