Inflation rates have come down since their peak in mid-2022. Does the Federal Reserve need to continue its inflation-fighting ways, keeping interest rates high? Anil Ari, Carlos Mulas-Granados, Victor Mylonas, Lev Ratnovski, and Wei
Zhao of the IMF look to historical and international experience in “One Hundred Inflation Shocks: Seven Stylized Facts” (September 2023, WP/23/190).
As background, here’s a standard measure of inflation from the US Bureau of Labor Statistics, showing monthly data on the rise in the Consumer Price Index over the previous 12 months. You can see the peak at above 8% in mid-2002, and the more recent decline to the range of 3-7%.
The IMF authors are careful to note that they are just looking at patterns from past episodes: that is, they are not claiming that history will necessarily repeat itself. They describe the underlying data this way:
This paper identifies over 100 inflation shock episodes in advanced and emerging economies between 1970 and today. Over half of these episodes are linked to the 1973 and 1979 oil crises—large commodities-related, terms-of-trade and supply-side shocks—making them particularly insightful for today’s policy debates. The remaining inflation shocks in our sample have various origins, including demand surges and/or sizeable exchange rate depreciations.
Here are their seven lessons.
Fact 1: Inflation is persistent, especially after a terms-of-trade shock
We start the analysis by documenting how long it took to resolve inflation shocks historically, i.e., to bring inflation back to within 1 percentage point of its pre-shock rate. The results … caution against anticipating speedy disinflation. Only in under 60 percent of episodes in the full sample (64 out of 111) was inflation resolved within 5 years after a shock. Even then, disinflation took on average over 3 years.
By this metric, the lower rate of inflation in the last year or so has been relatively rapid. The current inflation rate of 3-4% is about 1-2 percentage point above the pre-shock inflation rates that had been running in the range of 2-3%.
Fact 2. Most unresolved inflation episodes involved “premature celebrations”
In about 90 percent of unresolved episodes (42 out of 47 in the full sample, and 28 out of 32 during the 1973–79 oil crises), inflation declined materially within the first three years after the initial shock, but then either plateaued at an elevated level or re-accelerated. One possible explanation for “premature celebrations” relates to base effects. As the factors behind the initial inflation shock recede (e.g., energy prices revert, alleviating the terms-of-trade shock), headline inflation may decline
temporarily despite sticky underlying inflation. Another possible explanation relates to inconsistent policy settings, such as premature policy easing in response to declining inflation …Fact 3: Countries that resolved inflation had tighter monetary policy
The IMF authors emphasize here: “The key finding is that the successful resolution of inflation shocks was associated with more substantial monetary policy tightening.”
Fact 4. Countries that resolved inflation implemented restrictive policies more consistently over time
In addition to tighter macroeconomic policies per se, the policy stance in countries that resolved inflation was maintained more consistently over time …
Fact 5. Countries that resolved inflation contained nominal exchange rate
depreciationOur data demonstrate that countries which successfully resolved inflation better maintained nominal exchange rate (ER) stability …
Exchange rate issues are less important for the enormous US economy, with its relatively low ratio ratio of trade-to-GDP compared to many other countries.
Fact 6. Countries that resolved inflation had lower nominal wage growth
We also analyze labor market outcomes, specifically wages. Due to lack of historical data on wages, and for this result only, we use the full sample of episodes during 1973–2014. We document that, in countries which resolved inflation, nominal wage growth moderated after the inflation shock.
This finding will be unhappy news for wage-earners. After a burst of inflation, w would all like it if our wages would also rise, so that we can catch up with the higher price levels. But lower overall wage growth is what tends to keep inflation tamped down.
Fact 7. Countries that resolved inflation experienced lower growth in the short term but not over the 5-year horizon
The pandemic recession is its own distinctive economic event, so I wouldn’t want to overinterpret these historical patterns in terms of policy advice. But some warnings here are worth noting. Have a consistent monetary policy. Beware of “premature celebrations” that inflation is over. Recognize that even if fighting inflation involved short-term losses in economic output, such losses are typically not lasting or permanent.
