Apr 20 -- Inflation Persistence: How Much Is There and Where Is It Coming From?
The surge in inflation since early 2021 has sparked intense debate. Would it be short-lived or prove to be persistent? Would it be concentrated within a few sectors or become broader? The answers to these questions are not so clear-cut. In our view, one should ask how much of the inflation is persistent and how much of it is broad-based. In this post, we address this question through a quantitative lens. We find that the large ups and downs in inflation over the course of 2020 were largely the result of transitory shocks, often sector-specific. In contrast, sometime in the fall of 2021, inflation dynamics became dominated by the trend component, which is persistent and largely common across sectors.
To address the issues of inflation persistence and broadness, we estimate a dynamic factor model on monthly data for the seventeen major sectors of the personal consumption expenditures (PCE) price index. The model (which builds on this paper) decomposes each sector’s inflation as the sum of a common trend, a sector-specific trend, a common transitory shock, and a sector-specific transitory shock. From sectoral level estimates, we then construct the trend in PCE inflation as the sum of the common and sector-specific trends weighted by the expenditure shares. We estimate the model using data from all sectors; however, in constructing the trend in PCE inflation, we exclude the non-core sectors (that is, food and energy). We thus refer to the measure as a Multivariate Core Trend (MCT) of PCE inflation.
Compared to the widely used core PCE inflation measure, which simply removes the volatile components, the MCT seeks to further remove the transitory variation from the core sectoral inflation rates. This is key in understanding recent inflation developments because during the pandemic many core sectors (motor vehicles and furniture, for example) were hit by unusually large transitory shocks. An ideal measure of inflation persistence should filter those out.