This paper proposes a simple framework to help monitor and understand movements in PCE inflation in real time. The approach is to decompose inflation using simple categorical-level regressions or systems of equations. The estimates are then used to group categories into components of PCE inflation. I review some applications of the methodology, and show how it can help explain inflation dynamics over recent episodes. The methodology shows that inflation remained low in the mid-2010s primarily because of factors unrelated to aggregate economic conditions. I also apply the methodology to the Covid-19 pandemic. The decomposition reveals that a majority of elevated inflation in core PCE inflation in the 2021 2022 period was due to "Covid-sensitive" categories, that is, those categories where prices and quantities moved the most at the onset of the pandemic. Finally, I show how the methodology can be applied in a dynamic fashion, labeling categories as either supply- or demand-driven by month. This decomposition allows one to assess the extent to which supply and demand factors are impacting inflation.
Hale Shapiro, Adam. 2020. “A Simple Framework to Monitor Inflation,” Federal Reserve Bank of San Francisco Working Paper 2020-29. Available at https://doi.org/10.24148/wp2020-29