Webinar Video COVID-19 Inflation

Geneva 26: The Art and Science of Patience: Relative prices and inflation

When inflation started growing rapidly in 2021, some economists saw it as the consequence of the large fiscal stimulus implemented during the COVID-19 pandemic, while others thought it was a transitory response to a large negative supply shock. These two interpretations led to different views on the desirable length of time over which central banks should return inflation to target.

The Peterson Institute for International Economics (PIIE) and the Centre for Economic Policy Research (CEPR) present the 26th Geneva Report “The Art and Science of Patience: Relative prices and inflation,” authored by Veronica Guerrieri, Michala Marcussen, Lucrezia Reichlin, and Silvana Tenreyro. The report documents how two large supply shocks, the COVID-19 pandemic and the war in Ukraine, affected relative prices in different parts of the world and makes recommendations on how monetary policy should react to these asymmetric shocks.

The authors observe that the pandemic and the war in Ukraine hit different sectors and regions with variable intensity and document how the combination of uneven shocks and price and wage rigidity led to a complex staggered dynamic of sectoral inflation. They also show that a demand shock would have led to a much lower degree of inflation heterogeneity across sectors.

The analysis has important policy implications. If elevated core inflation reflects that relative price and wage adjustments are necessary for an efficient resource reallocation when an economy with nominal rigidities is hit by an uneven shock, it may be necessary to tolerate a somewhat higher inflation rate to facilitate the relative price adjustment and the efficient allocation of resources across sectors.

This view calls for a more accommodative monetary policy stance relative to a setting in which the same level of inflation is generated by an even demand shock with no need for reallocation. Of course, policymakers need to be careful because the benefits of temporarily higher inflation to allow for relative price adjustments need to be balanced against the potential risks of de-anchoring inflation expectations.

Joseph E. Gagnon (PIIE) and Veronica Guerrieri (Booth School of Business, University of Chicago; National Bureau of Economic Research; CEPR) deliver the presentations. A Q&A moderated by PIIE senior fellow David Wilcox follows.



David Wilcox
Senior Fellow, PIIE


Joseph E. Gagnon
Senior Fellow, PIIE

Veronica Guerrieri
Booth School of Business, University of Chicago; National Bureau of Economic Research; CEPR