Money Supply and Inflation after COVID-19

Abstract

The core personal consumption expenditure (PCE) price index, the Federal Reserve’s preferred inflation gauge, rose to 5.2 percent on January 2022, which is the highest rate of increase since 40 years ago. Our estimates show that the annualized quarterly core PCE prices could reach 5.45% in the second quarter of 2022 and are as high as 8.57% in a longer time horizon unless corrected with restrictive monetary policies. Thus, the inflation shock since COVID-19 is not transitory, but it is persistent. As economists expect the Federal Reserve to tighten the money supply in March 2022, the insufficient policy responses may be attributed to a failure to incorporate a unique macroeconomic shock to unemployment during the pandemic. We propose a modified vector autoregression (VAR) model to examine structural shocks after COVID-19, and our proposed model performs well in forecasting future price levels in times of a pandemic.

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