MEANWHILE, THE ECONOMY JUST KEPT CHUGGING ALONG:

Inflation did shoot up, hitting 7% that December, 5.5% excluding food and energy. "The critics' forecasts of higher inflation would prove to be correct--indeed, even too optimistic--but, in substantial part, the sources of the inflation would prove to be different from those they warned about," Blanchard, one of those critics, and Bernanke write in their study.

To tease out the sources of inflation, Bernanke and Blanchard build a relatively conventional model in which inflation is a function of, among other things, the gap between the supply and demand for labor, the public's expectations of inflation, and idiosyncratic shocks. They include a variable for supply-chain disruptions derived from Google searches for "shortage."

Usually economists judge labor market tightness from how far unemployment is above or below its natural rate. But this time the labor market heated up before unemployment got that low. So instead, Bernanke and Blanchard use the ratio of job vacancies to unemployed workers. Finally, their model lets all these factors interact, with varying lags.

If stimulus caused the initial surge in inflation, it should have shown up in an overheated labor market, i.e., an unusually high ratio of vacancies to unemployed. In fact, labor market conditions put downward pressure on inflation through the third quarter of 2021, the authors concluded. Instead, the inflation that year was driven almost entirely by shortages and energy prices.

Demand shifted abruptly from services to goods in the early months of the pandemic. The overall effect should have been a wash as prices rose for goods and fell for services. It wasn't, because goods producers faced supply constraints, which caused costs and prices to spike, while costs to service producers didn't decline much. "These sectoral mismatches between demand and supply proved more intractable and longer-lasting than many had expected," the authors note.

These supply effects did eventually subside. Why didn't inflation then fall? The reason, the authors conclude, is that by this point demand was so strong, reflecting the legacy of low interest rates and fiscal largess, the labor market was significantly overheated with the ratio of vacancies to unemployed up dramatically. Moreover, the initial surge of inflation had an echo: It lifted workers' expectations of short-term inflation, which then partly found its way into their wages.

If anything, the study might understate the effect of pandemic disruptions. The labor market didn't just overheat because of excess demand, but reduced supply, as well. The rising ratio of vacancies to unemployed, which the model equates with a tighter labor market, reflects employers struggling to fill vacancies. The authors note much of that struggle was because of the pandemic: Firms that had laid off employees had to find new ones, while some workers left the labor force because of family obligations, illness or work-life balance priorities.

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