How Much Did Macroeconomic Policy Matter? A New Decomposition of the US Inflation Surge of 2021–22

Abstract: Many economists have argued that both supply and demand shocks contributed substantially to the recent inflation surge in the United States. By contrast, we argue that aggregate demand explains the bulk of inflation. We illustrate the relative importance of demand and supply shocks in two ways. First, we decompose deviations of nominal GDP from a Congressional Budget Office benchmark into inflation deviations from target and output deviations from potential output. Second, using a New Keynesian model of the US economy, we estimate a structural vector autoregression with long-run restrictions that identifies temporary supply shocks, permanent supply shocks, and aggregate demand shocks. We find that demand contributed to more than 60 percent of the excess inflation in 2021 and more than 85 percent of the excess inflation in 2022. These results indicate that the inflation surge was largely the result of macroeconomic policy choices rather than rare events beyond the control of policymakers.