U.S. Inflation During And After COVID-19

• Inflation in the U.S. has taken a significant step down due to the health crisis. The impact on demand has far outweighed the negative supply shocks. Most categories of spending have experienced price disinflation or outright price declines in March and April.

• As states reopen their economies, we will likely see some return of demand and upward price pressures. Nevertheless, inflation will remain weak due to a slow recovery in jobs and income.

• Over the long term, the outlook for inflation is less certain. Weak demand could keep inflation at low levels but continued policy support and supply constraints raises the possibility of rapidly rising prices. This will ultimately depend on the inflation tolerance of policymakers.

• The COVID-19 pandemic has inflicted negative supply and demand shocks to the economy. On the supply side, it has disrupted business operations, forced millions of layoffs, and rocked supply chains. From the demand perspective, consumers have greatly cut back on spending and businesses have cancelled investment plans.

• These shocks are reflected in price dynamics. While reduced supply raises prices, weaker demand weighs on them. With aggregate price indices, the consumer price index (CPI) and the personal consumption expenditures price index (PCEPI), declining since the beginning of the lockdown period, it is clear that demand weakness has outweighed supply shocks. Since February, the CPI has fallen by 1.2%, while the PCEPI has dropped by 0.7% (Chart 1). Usually, the difference between the two series is small and one-sided (CPI typically grows faster than PCEPI). But, recently, the gap has reversed and widened.

• This is primarily due to the scope and weighting of the two indices. The PCEPI covers a wider range of goods and services and shifts expenditure weights on a monthly basis as consumers adjust their spending behavior, unlike the CPI which updates weights less frequently. Given that consumers are actively shifting their consumption baskets due to COVID-19, the PCE deflator is more representative of underlying price pressures. Therefore, for the remainder of this note, we will use the PCEPI to examine inflation dynamics.

TD Bank