"Inflation During the Pandemic Was Temporary" US Fed Assessment Proven Correct

2024 BOK International Conference
Session 4 on the 31st: 'A Holistic Approach to Macroeconomic Fundamentals' Presentation
Christian Mathis, Professor at Indiana University, USA

A study has found that the assessment by the U.S. Federal Reserve (Fed) during the pandemic period that 'inflation is transitory' was correct. The Fed had faced criticism for triggering inflation with a 'zero (0) interest rate' in early 2020 when COVID-19 was spreading. The study revealed that even when inflation surged sharply after the pandemic, the long-term inflation rate stabilized at 2-3%.

Christian Matthes, a professor at Indiana University, USA, attended as a presenter for Session 4 at the ‘BOK International Conference’ held on the 31st at the Bank of Korea annex in Jung-gu, Seoul, and spoke on the topic ‘A Holistic Approach to Macroeconomic Fundamentals: Joint Estimation of the Natural Rate.’ The report pointed out that the volatility of macroeconomic data such as the unemployment rate increased before and after the pandemic and proposed a new methodology to more accurately measure the natural unemployment rate and the natural interest rate (neutral rate).

The natural unemployment rate refers to the level of unemployment that neither accelerates nor decelerates inflation. The natural interest rate (neutral rate) is the appropriate interest rate level that can achieve economic growth at the potential growth rate without overheating or recession in the economy.

Using U.S. data from the fourth quarter of 1891 to the fourth quarter of last year, the study estimated the long-term time series trends of unemployment rate, inflation rate, and (real) interest rate. The correlation coefficient between unemployment and inflation was around 0.5. This indicates that supply shocks had a greater impact on the long-term trend than demand shocks in the relationship between unemployment and inflation.

The correlation coefficient is a measure of the degree of correlation between two variables, with an absolute value closer to 1 indicating a stronger correlation.

The correlation coefficient between real interest rates and inflation was found to be -0.7. This suggests that lower real interest rates lead to inflation in the long term.

Professor Matthes stated, “Even when inflation surged sharply after 2022, the long-term inflation rate stabilized between 2-3%,” and analyzed, “Regarding the debate on whether inflation immediately after the pandemic was transitory or not, the estimation results aligned with the Fed’s judgment that it was ‘transitory.’”

He added, “However, it should be noted that uncertainty is very high, and there is a risk that inflation could rise further in the long term.”

Lucas Rachel, a professor at University College London (UCL), UK, who participated as a discussant, evaluated, “This addressed important policy questions during a period of high uncertainty caused by the pandemic.”

Petia Koeva, head of research at the International Monetary Fund (IMF), who also participated as a discussant, said, “The paper shows that uncertainty surrounding the long-term trend has significantly increased due to recent price rises.”