Understanding the surge in inflation has become a central concern for households and businesses alike. To effectively address this question, economists often dissect the overall inflation figure into two key components: core inflation and deviations from this core. Core inflation essentially reflects the underlying tightness or slack within the labor market. Meanwhile, deviations represent significant price fluctuations in specific sectors, often acting as unexpected shocks to the headline inflation rate. These shocks can subsequently ripple through the economy, contributing to increases in core inflation itself.
Throughout 2021 and 2022, a notable tightening of the labor market occurred, leading to a corresponding rise in core inflation. This increase was largely driven by a higher ratio of job vacancies to unemployment. This ratio serves as a crucial indicator of wage pressures, which are then passed on to the prices of goods and services. As employees gain bargaining power and seek higher wages, companies often respond by raising prices to offset these increased labor costs. Research points to three primary factors that have fueled the inflationary pressures since 2020: the volatile nature of energy prices, significant backlogs in orders for goods and services stemming from COVID-19 related supply chain disruptions, and notable price shifts within the automotive industry.
Looking ahead, predicting the future trajectory of inflation hinges on understanding two critical elements: the dynamic relationship between job vacancies and unemployment, and long-term inflation expectations. Central banks, like the Federal Reserve in the United States, typically combat inflation by raising interest rates. Economists’ forecasts for December 2024 inflation rates vary, projecting a range between 2.3 and 4.8 percent.
Analysis suggests that the increasing ratio of job vacancies to unemployment accounted for approximately one-third of the 2.0 percentage point rise in core inflation over a 12-month period. This 2.0 percentage point increase in inflation explains about half of the overall rise in core inflation, which climbed from 2.3 to 6.9 percent – a total increase of 4.6 percentage points. Furthermore, headline inflation shocks were primarily attributed to energy prices, contributing 2.7 percentage points, and backlogs in work orders, adding another 1.7 percentage points to the inflationary pressure.
