by Regis Barnichon and Adam Shapiro
Federal Reserve Bank of San Francisco
Inflation still lies somewhat above the Federal Reserve’s 2% goal after slowing significantly since its spring 2022 peak. Analysis shows that two labor market indicators—the ratios of job vacancies to unemployed workers and of vacancies to effective job seekers—are particularly informative in determining excess demand’s impact on recent inflation. The measures suggest that declines in excess demand pushed inflation down almost three-quarters of a percentage point over the past two years. However, elevated demand continued to contribute 0.3 to 0.4 percentage point to inflation as of September 2024.
The well-known Phillips curve explains the relationship between inflation and unemployment—specifically that inflation is high when overall demand exceeds overall supply. With current inflation still somewhat above the Federal Reserve’s 2% goal, it is plausible that excess demand remains in the economy. Our prior research found that labor market tightness as measured by the ratio of job vacancies to unemployment (V–U ratio) outperformed other common measure of excess demand in forecasting inflation (Barnichon and Shapiro 2022).