Council on Foreign Relations, New York, New York
As Prepared for Delivery
I appreciate the kind invitation to join you for this discussion of the US economy.
The Decline in Inflation amid an Expansion
Today, we are at an important turning point. Inflation is coming back down close to normal levels, and it is important to safeguard the important labor market progress we have made.
A few years ago, many were convinced that the combination of a large decline in inflation with a sustained expansion that we are seeing today couldn’t happen. They predicted inflation could only be brought back down at the cost of considerable dislocation in the labor market. They predicted a major slowdown would be required to bring inflation down.
Instead, inflation has come back down close to its level just before the pandemic, while we have maintained the lowest average unemployment of any administration in over 50 years, and real GDP has grown by 2.9 percent per year on average. December 2020 was the last month in which US employment declined; since then, employment has expanded for 43 months in a row. Consumers have remained resilient, small business creation has reached record highs, and incomes have risen by more than prices for median American households.
In short, the US economy achieved better unemployment and growth outcomes than predicted 2 years ago, while inflation came down in line with forecasts, as shown in Figure 1. The fact that inflation came down while employment continued to expand provides good evidence that the inflation surge was associated with several overlapping shocks associated with the pandemic and Russia’s invasion of Ukraine that dissipated over time.
In addition, the US has seen a stronger recovery than comparable countries, while inflation rose and fell in a similar pattern across countries, as shown in Figure 2. The fact that comparable countries experienced the same surge in inflation, while the recovery was stronger in the US, suggests that government policy differences mattered. While we must continue our work to lower costs, Administration policies to protect balance sheets and support small businesses, families, workers, and communities played an important role in supporting the broad-based recovery in the US, and early investments in fixing supply chains helped ease shortages and price pressures, along with ongoing supply-side investments.
The Shocks That Caused Inflation to Surge
As the inflation surge got underway, there was an important debate over whether it was primarily attributable to overall excess demand or to shocks that would dissipate over time. This had important implications for the stance of government policy.
In 2022, I highlighted three sets of shocks: shocks to supply chains and commodities; shifts in the ability of workers to participate in the labor force; and changes in the composition of demand. It now seems clear that these shocks played an outsized role in the inflation surge.
Supply Chains and Commodities Disruptions
Shipping bottlenecks and production stoppages constrained the supplies of key inputs like semiconductors and consumer products like autos, appliances, and electronics. The resulting inflation was exacerbated when Russia’s invasion of Ukraine sent global food and energy prices soaring.
At the sectoral level, it is now clear that price increases were concentrated in the sectors that had lower or even negative output growth between 2021 and 2023. This is what we’d expect to find if supply shocks, rather than overall excess demand, were the major driver of inflation. And this is corroborated at the aggregate level, where supply chain disruptions spiked and then moved back down to pre-pandemic levels, and inflation followed the same pattern with a lag, as we can see in Figure 3.
As inflation rose, many argued that the surge in inflation was caused by excessive growth, but we saw the opposite. Inflation skyrocketed in 2022 as growth and productivity went negative following the Russia commodities price surge. And inflation fell during 2023 and 2024, when growth and productivity took off.
Shift from Services to Goods
Inflation was exacerbated by a shift in demand away from services sectors to the goods sectors that were experiencing severe supply constraints. Due to the pandemic, people went out to eat less and bought more kitchen appliances, they relied on transportation services less and bought cars, and they went out to gyms less and bought exercise equipment. In response, prices rose rapidly for those goods where supply struggled to catch up. And the price of services did not fall to compensate for the surge in goods prices, so the overall rate of inflation rose. Later, as the share of spending on services moved back up towards pre-pandemic levels, the prices of services rose as the supply of services took time to respond, especially since capacity had contracted in areas like flights, hotels, and restaurants.
Housing saw a large shift in demand that put strains on existing supply. The jump in people working from home shifted demand to larger homes and changed the geography of many cities. Some estimates suggest that pandemic shifts account for more than half of the housing inflation we observed.
Labor Supply Shifts
Labor supply also saw large shifts over this period. There was an immediate drop in labor supply during the lockdown period, as workers went home and some retired early, and the subsequent waves of the pandemic kept labor market participation at lower levels.
In light of the highest quit rates on record, some commentators labeled this shift a “Great Resignation.” But ultimately we saw a “Great Rebound” with the highest hires rates on record, as a wave of people switched jobs to better, more productive ones. Many others started new businesses, and we have now seen a record 19 million new business applications. This reallocation actually led to improvements in incomes and balance sheets for many Americans relative to pre-pandemic levels, even after accounting for inflation.
Policy
The choices by workers and small businesses to pursue new opportunities brings us to the important role of government policy. The President and Vice President never wavered in their determination to support the recovery, fix supply chains and shortages, and support investments that will create opportunity for the future. Policy actions jumpstarted a broad-based recovery that lifted small businesses, working families, and the middle class, while making critical investments in the future.
First, the Administration took decisive action to support families, workers, businesses, and communities through the severe pandemic-related and geopolitical shocks. Support for the recovery helped to prevent the labor market scarring that can hurt workers throughout their careers. It enabled small businesses to reopen and start up in record numbers. It supported families and childcare to enable parents to get back to work. It helped bolster household and small business balance sheets, instead of saddling them with unmanageable debts due to circumstances beyond their control, which would have held the economy back.
Second, the President made a clear commitment to respect the independence of the Federal Reserve in fighting inflation. This was an important contrast to his predecessor, who repeatedly criticized Federal Reserve monetary policy during the previous administration.
Third, the Administration mounted a comprehensive effort to address price pressures by fixing supply chains, addressing commodities price spikes, and taking on affordability challenges for working families.
Gas prices at the pump are lower today than they were before Russia’s invasion of Ukraine sent gas prices soaring. This did not happen by accident. The Administration’s use of the Strategic Petroleum Reserve helped stabilize global energy markets while also earning a return for taxpayers; domestic oil production is strong; and we have made historic investments in the clean energy transition that will help diminish US reliance on volatile global energy markets over time.
We launched the Supply Chain Disruptions Task Force and worked with business and labor leaders to fix supply chains and unclog our ports, trucking networks, and shipping lines, making sure packages arrived in time for the holidays. We passed ocean shipping reform legislation and helped to reduce shipping costs for American manufacturers, farmers, and consumers. The number of ships waiting in the Port of Los Angeles has fallen from a peak of over 100 back down to pre-pandemic levels. We are investing in the long-term resilience of our supply chains, making a generational investment in infrastructure that will make it more cost effective for businesses to get goods to market and serve their customers.
The President and Vice President secured critical investment laws that are positioning America to be a global leader in the clean energy transition and in semiconductors and technologies such as AI, while creating good jobs and strong pathways to the middle class here in America. And these investments were paid for by improving tax fairness and by reducing spending on a bipartisan basis through the enactment of the Fiscal Responsibility Act.
The President and Vice President are working to address longstanding affordability challenges that have for too long limited economic security and mobility for middle-class and working families. They secured lower health insurance premiums for millions of Americans. And they passed historic legislation to cap the cost of insulin and out of pocket drug costs and negotiate prices on key prescription drugs for seniors, while also lowering the deficits.
We must continue to work together to tackle longstanding affordability challenges for middle-class families. We know that America needs more housing to address housing affordability challenges. That’s why it is critical to move forward on an ambitious plan to bring housing costs down by building millions of new affordable homes and providing incentives for states and localities to remove outdated obstacles to building.
It’s also essential we continue to enable more workers to participate in the labor force and to make it easier and more affordable to raise a family. We know that investing in children improves both their well-being and their future employment opportunities, and supporting child care expands access to better employment opportunities, especially for parents of young children. That is why it is critical to move forward on expanding the Child Tax Credit and ensuring childcare is affordable and accessible.
This is very different from an approach that would weaken our economy by undermining the independence of the Federal Reserve and the rule of law, add trillions to the debt, and impose what amounts to a sales tax of $4,000 on middle-class families.
Conclusion
Americans have been through a lot of hardship as a result of the pandemic. Together with American workers, businesses, and families, we have made important progress. With inflation coming back down close to normal levels, the focus now must be on safeguarding the important labor market progress we have made. And it is critical to continue our work together to address affordability challenges and create more opportunities for working families and the middle class.
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