What caused inflation in 2022?

Here is the part everyone agrees on: After many years of very moderate inflation, prices flew higher in 2022, reaching year-over-year price inflation levels not seen in decades. And while that inflation rate has since disinflated substantially, the increase in most prices has been “sticky.” Prices go up a lot easier than they come down, and with inflation sometimes the best one can hope for is that the rate of increase levels out and, of course, that wages keep up with price increases. Even then, though, the effects have never been felt proportionately. Lower wage earners feel it the most, and some standard of living is negatively affected.

A lot of theories have circulated since 2022 about the cause of that inflation. Government spending in 2020 and 2021 was outrageous, some of it likely necessary in the face of the COVID-19 pandemic, and much of it frivolous and wasteful. Yet out of the fact that a spending surge took place in 2020 and 2021 and inflation followed in 2022, the natural post hoc reasoning was that the government spending caused the inflation. History suggests a more nuanced view is in order.

Here is the challenge with the simpler view that big government spending caused inflation in 2022:

• The national debt went up $7 trillion from 2017 to 2020.
• Inflation was sub-2 percent from 2017 to 2020.
• The national debt went up another $3 trillion in 2021 and 2022.
• Inflation flew higher in 2022.
• Therefore, either a certain partisan spending causes inflation, like magic, or something other than big deficit spending caused inflation.

The first four points are all true, and yet some intellectual honesty requires us to say that it may be questionable to assert that one big batch of debt caused inflation when another big batch did not. And there is no reason to start this in 2017. Government debt from 2001 to 2020 went up by $25 trillion (80 percent), and yet inflation was very moderate the entire time. Japan’s government debt to gross domestic product was the highest on the planet for 30 years, and the country suffered deflation the entire time. What else could have caused the inflation of 2022 besides excessive government spending?

Some ideas include:

• Easy monetary policy (zero interest rates, quantitative easing, etc.). Here, again, 2009 to 2020 is a problematic counterfactual span, as is 30-plus years of Japan’s monetary policy. Highly interventionist and “easy” monetary policy is problematic and distortive for a lot of reasons, but it was certainly not inflationary for years and years before 2022.
• Too many people had jobs. OK, hopefully, no one would admit they think this, but the implicit belief of what is called the Phillips curve model is that high employment creates inflation. But unemployment was very high coming out of the pandemic and did not begin to drop until the peak of inflation. Not only is this theory wrong at every level, but the facts in 2021 and 2022 were the exact opposite!

I will suggest the explanation that stands up in this case out of all prevailing theories is a global shutdown had brought production to a standstill, collapsing the supply of goods and services to unprecedented lows, even as the money supply was increasing.

I have never discounted that other factors worsened the inflation surge of 2022 (i.e., labor shortages from government extension of transfer payments, a change in the transmission mechanism of quantitative easing versus the use of the banking system in 2009, etc.). But they are all secondary to the simplest explanation when it comes to what happened to the broad price level. Idiosyncratic factors existed in specific sectors (housing is a great example as the lowest interest rates on record drove record demand even as no new supply came to market). But the broad inflation level was pushed higher by a lack of global supply, caused by the policy decision of global shutdowns.

The vanilla statement that “government spending causes inflation” lacks necessary nuance and qualification. I assume no one would want to qualify it by saying, “One political party’s government spending causes inflation while the other party’s spending magically does not.”

I not only believe that the effect of the COVID shutdown was the major factor in 2021 and 2022 inflation, but at this point, I believe it is abundantly obvious that it was. This ought to intensify our attention on the global supply chain. The correlation in the chart below is impossible to argue with. When supplies, deliveries, and a healthy flow of manufacturing are working, prices moderate; when the supply chain is broken, prices escalate.

There is plenty of blame to go around for the inflation of 2022, and single causation identification is tempting but generally inadequate. The primary cause of inflation continues to be what Milton Friedman taught us so well: too much money chasing too few goods.