US central bank sees inflation differently based on its cause

The US central bank has historically treated inflation caused by too much spending differently from inflation caused by supply shortages. Since the 1980s, it has reacted more strongly to inflation it believes is caused by demand. This means that when prices rise because people are buying too much, the central bank acts faster to cool things down. When prices rise because there aren't enough goods, the central bank's response has been less aggressive, and those price increases tend to stick around longer.

For decades, the US central bank has operated with an assumption about inflation. It believed that demand-driven inflation was the primary problem to solve. This research shows that assumption has shaped its actions, leading it to react more forcefully to certain price signals than others. This asymmetry means that supply-driven price shocks, which are becoming more common, may persist longer because the central bank is less inclined to act aggressively against them. Financial markets also react differently, with demand issues moving interest rates and supply issues inflating risk premiums for investors.