The Road to 2% Inflation: Are We There Yet?

Five years after the start of the COVID-19 pandemic, prices are 10% above their prepandemic trend. Inflation peaked in mid-2022 and has since declined sharply, though progress towards the Federal Reserve’s 2% target may have stalled recently. This inflation episode was and remains broad-based, with most product categories still experiencing higher inflation than before the pandemic. In this blog post, I will provide an account of the inflation surge, the road back to 2%, and where we are today according to the latest data available.

The Recent Path of Inflation

The first figure plots the monthly evolution of the personal consumption expenditures (PCE) price index from January 2016 to December 2024, along with a line indicating its prepandemic (2016-19) trend. Before the onset of the pandemic, prices were growing at a steady rate of 1.7% annually, which was slightly below the Federal Reserve’s 2% target.

Evolution of the PCE Price Index

SOURCES: Bureau of Economic Analysis and author’s calculations.

There are three stages describing the dynamics of prices in 2020-24. First, during the initial phase of pandemic, prices actually fell below the trend. Then, from late 2020 until mid-2022, prices grew at a rapid pace. Since then, prices have been growing at a slower rate, though still faster than the prepandemic trend. By December 2024, prices were roughly 10% higher than their prepandemic trend. In other words, consumers were paying, on average, 10% more than what they would have paid had the pandemic not occurred.

The second figure plots headline inflation, that is, the change in the price level, measured here as the 12-month change in the PCE price index. One can clearly see the initial sharp drop in inflation, followed by a fast surge that peaks in mid-2022, and followed by a steady decline towards 2%.

PCE Inflation Rates and the Federal Funds Rate

SOURCES: Bureau of Economic Analysis, Board of Governors of the Federal Reserve System and author’s calculations.

The large volatility in energy prices impacts the PCE price index and may mask underlying trends. Thus, it is helpful to exclude energy prices in measured inflation.Note that energy goods and services only account for 4% of consumption expenditures. Another, more popular procedure is to exclude both food and energy prices (what is known as core inflation). However, food prices have not proved to be very volatile in recent times and have behaved in line with other prices. Their exclusion (which amounts to excluding 8% of consumption expenditures) risks removing an important aspect of the COVID-19 episode. For more food on being a good predictor of headline inflation, see Michael McCracken’s 2023 blog post “What Do Components of Key Inflation Measures Say about Future Inflation?” The resulting series is also plotted in the second figure. Excluding energy prices implies a less volatile inflation series that nevertheless follows the same broad pattern as headline inflation. Comparing the two series, however, reveals that much of the progress on inflation in 2024 was the product of falling energy prices. Excluding the direct effect of energy prices on inflation reveals that convergence to the Federal Reserve’s target may have stalled.

Finally, the second figure also plots the federal funds rate, which is the Federal Reserve’s main tool for conducting monetary policy. Despite inflation taking-off in 2021, the Federal Reserve did not raise this rate until March 2022.Note that the Fed started pivoting in November 2021 by reducing the pace of asset purchases. See Fed Chair Jerome Powell’s 2024 account of monetary policy during the COVID-19 pandemic. The rate rose sharply after the initial increase and remained elevated until the normalization process began in September 2024.

Inflation Remains Broad-based

One key property of the COVID-19 inflation episode is that it was broad-based. Initially, accounts of price surges in particular products gave the impression that inflation might be short-lived. As 2021 progressed, inflation was better understood as a broad phenomenon and no longer deemed transitory, which resulted in the strong subsequent tightening by the Fed.In October 2021, using data up to August of that year, I argued that high inflation could not be attributed to a small group of goods and services and should instead be viewed as a more generalized event. See my blog post “How Widespread Are Price Increases in the U.S.?”

The third figure shows how the distribution of inflation evolved over time. The figure estimates the distribution of inflation across product categories, with annualized price changes on the horizontal axis and the corresponding expenditure shares on the vertical axis. The first line displayed is the estimated distribution of inflation for 2016-19, which serves as a benchmark for the prepandemic period.The disaggregated data published by the Bureau of Economic Analysis consist of 244 product categories with monthly series on expenditures, prices and real quantities. There is some double counting in the report, so the actual number of product categories is slightly smaller. See NIPA tables 2.4.4U, 2.4.5U and 2.4.6U. For a full description of the methodology, see my 2021 blog post “How Widespread Are Price Increases in the U.S.?”

Estimated Distribution of Annualized PCE Inflation

SOURCES: Bureau of Economic Analysis and author’s calculations.

NOTE: View an animated version of this figure.

As we move to 2020, we can see the deflationary pressures during the early pandemic period, as there is a larger share of consumption expenditures on products experiencing a fall in prices (shown by the slight leftward shift in the distribution curve). The 2021 data show both the contribution to inflation of outliers (that is, products experiencing very high price increases) and a widespread shift of the distribution to the right (that is, consumption expenditures were more concentrated on categories experiencing higher inflation rates than in the prepandemic period). The shift to the right of the inflation distribution reached its peak in 2022. In 2023 and 2024, the distribution of inflation began gradually moving to the left, shifting back toward the prepandemic distribution.

The distribution of inflation in 2024 remains significantly to the right of the distribution in the prepandemic period. There are still a significant share of product categories experiencing high inflation rates and not enough categories experiencing low or negative inflation rates. About three-quarters of consumption expenditures in 2024 were on product categories experiencing higher inflation rates than in the prepandemic period. Thus, achieving the 2% inflation target will not simply involve the normalization of a few product categories, but rather a more generalized decline in inflation rates across the board.

Inflation by Major Product Categories

The table below offers a similar view by breaking down inflation into major product categories. As we can see, energy is the only major category that experienced lower inflation rates in 2024 than in the prepandemic period (2016-19). All other categories registered significantly higher inflation rates. For example, though average prices for core goods declined in 2024, they did not decline as fast as in the prepandemic period. Food, core services and housing all experienced much higher inflation rates. This resulted in inflation ending 2024 at 2.6%, almost a full percentage point higher than in 2016-19 and still more than half a percentage point above the Fed’s inflation target.

Are We There Yet?

On average, prices are now 10% higher than their prepandemic trend. In 2024, inflation was 2.6%, still somewhat elevated but getting closer to the Federal Reserve’s 2% target. Energy prices helped bring down inflation in 2024. In contrast, no single major category of goods and services is responsible for keeping inflation above target. The inflation episode that started in 2021 was and remains broad-based.

In an upcoming post, I will argue that inflation was predominantly caused by the fiscal response to the pandemic, supported by accommodative monetary policy. Given the current fiscal outlook, there may be further inflationary pressures ahead.

Notes

1. Note that energy goods and services only account for 4% of consumption expenditures. Another, more popular procedure is to exclude both food and energy prices (what is known as core inflation). However, food prices have not proved to be very volatile in recent times and have behaved in line with other prices. Their exclusion (which amounts to excluding 8% of consumption expenditures) risks removing an important aspect of the COVID-19 episode. For more food on being a good predictor of headline inflation, see Michael McCracken’s 2023 blog post “What Do Components of Key Inflation Measures Say about Future Inflation?”
2. Note that the Fed started pivoting in November 2021 by reducing the pace of asset purchases. See Fed Chair Jerome Powell’s 2024 account of monetary policy during the COVID-19 pandemic.
3. In October 2021, using data up to August of that year, I argued that high inflation could not be attributed to a small group of goods and services and should instead be viewed as a more generalized event. See my blog post “How Widespread Are Price Increases in the U.S.?”
4. The disaggregated data published by the Bureau of Economic Analysis consist of 244 product categories with monthly series on expenditures, prices and real quantities. There is some double counting in the report, so the actual number of product categories is slightly smaller. See NIPA tables 2.4.4U, 2.4.5U and 2.4.6U. For a full description of the methodology, see my 2021 blog post “How Widespread Are Price Increases in the U.S.?”