In our first test, we estimate the half-life of high inflation: the amount of time it takes for inflation to fall by half, from 4% to 2%, from 6% to 3%, and so forth. For some of the cases of 4% (or higher) inflation, inflation arrives and then recedes; for others, it accelerates further—in some instances, a lot further—before receding.5
The following graph shows the median number of years for inflation to be reduced by half, from the first time it hits one of the inflation thresholds we study. The shaded band representing the middle three quintiles (leaving out the top and bottom 20% of outcomes). The distribution includes cases when inflation reaches the next threshold (accelerating inflation), or does not reach the next threshold before receding (cresting inflation).
We find that once inflation has reached the 4% threshold, at the low end of the gray band, at one year, tells us that 20% of the time it takes a year or less to revert to ≤ 2% inflation (half of the 4% threshold). At the other extreme (at the top of the gray band), 20% of the time, it takes 10 years or more to fall back to 2%! The median result is a 2½-year wait before a modestly elevated 4% inflation falls below 2%. All of which invites the question: When inflation was already crossing 4% in April 2021 (2% of which was in the prior three months, which was an 8% annualized rate!), what were Powell and Yellen thinking in declaring the inflation transitory? Should we consider a median expectation of 2½ years to revert to a 2% inflation rate as transitory?
The medians for cresting inflation and for accelerating inflation are very different. Cases of cresting inflation dominate the lower reaches of the distribution, while cases of accelerating inflation dominate the top of the distribution. If 4% inflation never makes it to the next threshold of 6%, then this cresting inflation recedes quickly, with a median time of just 1 year to revert to ≤ 2%. But if inflation is accelerating and proceeds to the next threshold of 6%, and perhaps higher trouble likely awaits. In this situation, with a median of 10 years until the inflation level returns to 2%, the economy could face a protracted period of high inflation. At a 6% threshold, if inflation crests and recedes, the median is 15 months for inflation to fall by half (i.e., to revert to 3%). If instead inflation proceeds to 8% or more, the median time to revert to 3% is nearly 11 years.