Inflation began to rise in 2021 due to pandemic-related supply chain disruptions and reopening efforts. The Russia-Ukraine war that began in February 2022 intensified these pressures through a commodity supercycle (a widespread and sustained rise in energy and raw material prices), sending an inflationary shock to nearly all major economies, including the United States, with CPI inflation peaking at 9.1% in June 2022 (see Figure 1). But what makes this event noteworthy is not how inflation rose, but rather how it appears to taper off starting in 2023.
Figure 1. Core and headline inflation
Headline inflation rose sharply in 2022 and then fell rapidly, while core inflation fell more slowly.
Source: FRED and author’s own calculations
When inflation was rising rapidly in 2022, it was predicted that continued high unemployment would be necessary to bring inflation back to the Federal Reserve’s 2% goal. Such predictions are closely consistent with the results of the classical Phillips curve, which hypothesizes a trade-off between inflation and unemployment. These predictions were strongly rooted in the sacrifice ratio, or the fact that lowering inflation by one percentage point typically requires an increase in the unemployment rate.
Historical experience shows that inflation has fallen significantly without unemployment rising significantly, although the sacrifice rate can be substantial. It remained low from 2021 to 2022, varying between 3.6% and 3.9%. The casualty rate was found to be close to zero.
The big question these events raise is whether economists overestimated the persistence of supply-side shocks and the sensitivity of inflation to unemployment. Empirical evidence suggests that the Phillips curve was flatter, indicating less sensitivity of inflation to changes in the unemployment rate, and that inflation expectations were strongly anchored around the 2% target (Blanchard and Bernanke, 2023).
The situation that unfolds in 2025-2026 will be considerably different and perhaps more difficult than the situation faced in 2022-2023. The 2025-2026 tariffs provide evidence that may expand our understanding of:
1. Supply-driven inflation works; 2. Policy can be used to combat inflation without sacrifice.
From 2025 to 2026, the average U.S. tariff rate increased from 2.4% to nearly 18%. This increase resulted in $195 billion in tariffs in fiscal year 2025 (Yale Budget Lab, 2025). Research shows that American companies expect tariffs to account for 40% of total unit price growth from 2025 to 2026 (Bostic, 2025). At the same time, more than 55% of companies will cite geopolitical factors as their top supply chain concern by 2025, up from just 35% in 2023 (Risk Management Magazine, 2025).
The decline in inflation without a rise in unemployment highlights the importance of incorporating entrenched supply-side dynamics and expectations into macroeconomic policy.
Supply chain disruptions and energy price shocks did not last as long as expected during the 2022-2023 inflation episode. Energy prices have fallen significantly, from over $120 per barrel in June 2022 to $70-90 per barrel in late 2023 (see Figure 2). Global supply chain pressures will also normalize by mid-2023 (Morales, 2025). Economists were wrong about the duration of this shock, widely predicting that supplies and energy pressures would continue to rise through 2024, rather than normalizing by mid-2023.
Figure 2. Brent crude oil price
Brent oil prices have fallen sharply from their peak in mid-2022 and are at even lower levels by late 2023.
Source: Fred
Experience in the 1970s suggested prolonged supply-side shocks and unemployment costs associated with disinflation (Dolan, 2023). The supply-side environment of the 2020s is different in important ways. Moreover, supply shocks caused by tariffs behave differently than pandemic-era disruptions.
According to the analysis of Cavallo, Llamas, and Vasquez (2025), prices of imported goods increased by approximately 4% to 6.2% between March and September 2025, while domestic products increased by 2% to 3.6%. Prices of domestically produced goods have also risen, suggesting that tariffs are creating more inflationary pressures than imports.
Despite low unemployment, the labor market showed resilience as returning workers kept wage growth at moderate to low levels. Wage growth slowed from 5.9% in March 2022 to 4.3% in October 2023, indicating that labor market pressures have eased and inflation has fallen without sacrificing jobs (see Figure 3). Many observers initially thought that as people returned to work, companies would have to continue to raise wages significantly to attract them, further increasing price pressure. Rather, the increase in available workers made it easier for businesses to hire without raising wages as much, so wage growth slowed even though unemployment remained low.
Figure 3. U.S. wage growth and unemployment rate
Despite low unemployment rates, wage growth has slowed.
Source: FRED and author’s own calculations
The Fed’s high credibility has been important in keeping inflation expectations around the Fed’s 2% target. When expectations are “fixed,” people do not plan for continued large price increases because they primarily believe that inflation will remain around 2%. The Fed’s credibility, combined with its active communications strategy, appears to be establishing a regime of expectations that limits the second-order effects of wage-price spirals (increased wages drive up costs, which in turn causes further price increases). This reflects a fundamental policy shift from adaptive expectations to anchored expectations tied to central bank-set targets.
Inflation targeting central banks and the entrenchment of inflation expectations were largely theoretical before the 2021-2022 inflation episode. This idea became a reality as inflation tapered while unemployment remained near historic lows, as evidenced by the five-year breakeven inflation rate remaining stable at around 2%.
Despite tariff pressures, long-term inflation expectations remain relatively stable. Atlanta Fed President Rafael Bostic said in November 2025 that inflation poses a greater risk to the Fed’s dual mandate of price stability and maximum employment, while Vice Chairman Philip Jefferson said the “lack of progress” on the inflation target “appears to be due to the impact of tariffs.” The challenge for policymakers is to distinguish between the temporary price level effects of tariffs and persistent inflationary pressures that require monetary tightening (raising interest rates to cool demand).
The 2021-2023 inflation episode shows that the cost of supply-driven disinflation can be close to zero if shocks are temporary and expectations remain fixed. But 2026 brings other challenges. Inflation remains above the Fed’s 2% target and the labor market is currently weak. With unemployment already rising, the Fed cannot use its 2021-2023 strategy of maintaining tight policy and waiting for supply pressures to subside. Further monetary tightening to combat tariff-induced inflation risks further job losses, slowing employment and slowing income growth for workers.
One important lesson for policymakers is to stop looking away from supply-side dynamics, such as supply chain disruptions or sudden increases in raw material costs that push prices up from the production end. Forecasts of future inflation must take into account the temporary nature of supply shocks. This lesson applies directly to current tariff-driven inflation. While the Fed can keep expectations in place through clear communication, it cannot offset the direct price level effects of tariffs without imposing economic costs. The policy challenge is further complicated because tariffs are a discretionary policy choice rather than an exogenous shock.
The experience of 2021-2023 and the current environment in 2025-2026 highlight the importance of coordination between monetary and trade policies. A recent analysis by Yahoo Finance (2025) based on JPMorgan Global Research estimates that the announced tariffs could increase consumer spending prices by 1.0 to 1.5 percentage points in 2025. Central banks’ credibility needs to be carefully maintained, as it can be undermined if policy-induced shocks repeatedly push inflation above target.
The challenge in 2025-2026 is to respond to a different type of supply shock, caused by trade policy distortions rather than supply chain disruptions, while minimizing economic disruption.
An important lesson for policymakers is that when inflation expectations are fixed and supply shocks are differentiated from demand pressures, the costs of disinflation can be much lower than traditional models suggest. Achieving disinflation at such low cost requires maintaining policy coordination and central bank credibility in an environment of extraordinary uncertainty.
