A useful term, base effects, helps explain dramatic increases in GDP and other barometers of activity as economies recover from the COVID-19 pandemic. The term places such indicators in the context of a recent anomaly—in this case the dark, early stages of the pandemic that depressed global economic activity.
Base effects help mask the reality that activity hasn’t yet reached pre-pandemic levels in most of the world, that labor markets are still notably lagging despite recent strength in some places, and that the threat from the disease itself remains high, especially in emerging markets. These amplified comparisons to previous weak numbers portray a U.S. economy going gangbusters. Inflation is the next indicator to be roiled in this way.
It’s quite possible that base effects, as well as supply-and-demand imbalances brought about by the pandemic, could help propel the U.S. Consumer Price Index (CPI) toward 4% or higher in May and core CPI, which excludes volatile food and energy prices, toward 3%. All else being equal, we’d expect inflation to fall back toward trend levels as base effects and a shortfall in supply fade out naturally.
But inflation, once it takes hold in consumers’ minds, has a particular habit of engendering more inflation. Beyond that, all else is not equal.