Fighting the Pandemic Inflation Surge of 2021-2022

The Covid-19 pandemic, aggravated by the Russia-Ukraine war, unleashed the worst inflation in four decades in the United States and other advanced economies. This study reviews the contributions of supply shortages and excess demand to the inflation surge. It argues that too little attention was given to the need to finance pandemic relief through higher taxes, and to focus relief expenditures efficiently. Only about 40 percent of pandemic fiscal relief was focused on sectors and recipients most affected by the pandemic. The analysis posits a “fiscal quantity theory” whereby, under constrained supply, an increased fiscal deficit causes increased inflation proportionate to the resulting rise in demand relative to GDP. Calculations applying this approach to the timing of increased demand from fiscal relief, under alternative assumptions about severity of the supply constraints to US supply, find that fiscal pandemic relief contributed one-third to two-thirds of the total cumulative pandemic price shock amounting to 7.7 percentage points above baseline inflation over 2020-2022. The analysis urges greater attention to 6-month annualized inflation as a metric for monitoring progress in fighting inflation. This measure shows that trend US inflation fell from a peak of about 7½ percent in June 2022 to about 4½ percent in January 2023. As a possible supplementary policy instrument to curb still high inflation if needed, it suggests a contingent version of the income-tax surcharge employed in the United States in the late 1960s.