Redistributive policy

Understanding the global rise in inflation

A salient feature of the ongoing recovery from the Covid-19 recession is its lopsided nature. Around the world, demand for goods is buoyant, while demand for contact-intensive services is weak (Chart 1). Considering that goods are generally traded between countries while most services are not, the global economy is indeed experiencing a significant reallocation of demand from non-tradable services to tradable goods. Unsurprisingly, this period of exceptionally high global demand for goods is associated with rising commodity prices and strains on global supply chains (Eo et al. 2022).

Figure 1 Share of goods and services in total consumption expenditure

To note: See Fornaro and Romei (2022a) for data sources.

In a recent paper (Fornaro and Romei 2022a), we propose a multi-country Keynesian model with multiple sectors to understand the macroeconomic implications of this unusual demand pattern. Our analysis is organized around three questions: What is the optimal monetary policy response to a reallocation of global demand from services to goods? How do international spillovers shape the global recovery and inflation outlook? Are there gains to be made from international cooperation?

Monetary policy and structuralist approach to inflation

We study a world composed of countries producing tradable goods and non-tradable services. Nominal wages are sticky, so monetary policy has real effects, and involuntary unemployment can occur due to weak demand. We consider an overall reallocation shock, i.e. a temporary increase in consumer demand for goods relative to services, leading to an increase in the share of consumer spending on goods similar to that seen during the pandemic .

Our first idea is that this reallocation of demand from services to goods can push the global economy into stagflation. Intuitively, a drop in demand prompts companies in the service sector to reduce production and lay off part of their workforce. To contain the rise in unemployment, an increase in inflation in the market sector is needed. On the one hand, higher prices induce firms in the goods sector to hire more workers and increase production. Moreover, as workers receive more income from the market sector, their demand for services increases.1 Thanks to this income effect, the rise in the prices of goods also increases employment in the service sector.

The optimal monetary policy offsets the costs resulting from high inflation against employment gains.2 A reallocation shock therefore acts as a cost-push shock, leading to a simultaneous rise in inflation and unemployment. These results are consistent with the structuralist view of inflation (Olivera 1964, Tobin 1972, Guerrieri et al. 2021), which argues that some inflation is needed to smoothly reallocate workers between different sectors. However, this literature has mainly focused on closed economies, while we are interested in its international implications.

Capital flows, trade imbalances and inflationary spillovers

In a financially integrated world, a country can increase its consumption of traded goods by borrowing from the rest of the world and running trade deficits. Indeed, in our model, the regions experiencing the strongest increase in demand for traded goods adjust by posting trade deficits vis-à-vis the rest of the world. This helps explain why the US trade balance deteriorated in the recovery from the Covid-19 recession, as in the US the rise in consumption of goods was particularly pronounced.

Trade deficits, however, generate international inflationary spillovers. When a country runs a trade deficit, it exacerbates the scarcity of tradable goods on world markets and aggravates the trade-off between inflation and employment in the rest of the world. Through this channel, a country experiencing an increase in its demand for tradable goods exports high inflation abroad.

Our work thus formalizes the idea that global factors play an important role in the recent rise in inflation, which has been largely synchronized across advanced economies (Forbes et al. 2021). He also cautions against using inflation differentials to measure the strength of relative demand, for example between the United States and the euro zone. The reason for this is that the strong demand for goods in the United States, and the associated trade imbalances, also increase inflation in the euro zone. A more comprehensive approach to understanding demand differentials should therefore look at a combination of inflation and trade imbalances.

Free riding and gains from monetary policy cooperation

We also highlight the presence of a free rider problem between national central banks, which arises when global demand for tradable goods is exceptionally high. When a country implements monetary expansion, it promotes its production of traded goods and increases its net exports to the rest of the world, thereby easing pressure on global tradable goods markets. As global consumers access a greater supply of tradable goods, their demand for non-tradable services increases. Through this channel, a monetary expansion raises aggregate demand and employment not only at the national level, but also in the rest of the world.

The presence of this spillover from international aggregate demand implies that national central banks are likely to fall into a coordination trap. The reason is simple. Inflation costs associated with monetary expansions are borne entirely by domestic agents. Gains in terms of increased demand and employment partly benefit the rest of the world. National monetary authorities therefore have an incentive to take advantage of foreign monetary expansions for free, which means that the lack of international cooperation can lead to excessive unemployment during periods of exceptionally high demand for tradable goods.

This result is linked to the debate on international externalities triggered by countries with large trade surpluses. A long tradition holds that current account surpluses are detrimental when global demand is scarce, as they export weaknesses in domestic demand abroad.3 But we show that things are very different when global demand for tradable goods is high, such as during the recovery from the Covid-19 recession. In this case, policies that promote domestic production of tradable goods – and current account surpluses – ease pressure on the global goods market and act as a benign disinflationary force on the rest of the world. These considerations suggest that current account surpluses should be discouraged when global demand is weak, but encouraged when the weakness concerns global supply. Of course, this makes designing a system to regulate international trade imbalances a daunting task.

Energy shocks in the global economy

Partly due to the Russian invasion of Ukraine, world energy prices are rising rapidly. In ongoing work (Fornaro and Romei 2022b), we show that rising energy prices exacerbate all the stagflationary forces described above. In fact, high energy prices increase production costs for manufacturing companies, leading to a global shortage of tradable goods. As noted above, when traded goods are scarce, central banks face a trade-off between inflation and employment, trade deficits impose deflationary spillovers on the rest of the world, and monetary expansions produce positive demand spillovers in the rest of the world. foreign countries. The main difference is that in this case the Eurozone, due to its reliance on Russian energy, is likely to be the most affected region, which means the ECB could face a particularly difficult trade-off. between controlling inflation and maintaining economic activity.


Eo, Y, L Uzeda and B Wong (2022) “Goods Inflation Likely Transient, But Upside Risks to Longer-Run Inflation Remain”,, 29 April.

Fornaro, L and F Romei (2019), “The paradox of global thrift”, American Economic Review 109(11): 3745-79.

Fornaro, L and F Romei (2022a), “Monetary policy during lopsided global recoveries”, CEPR Working Paper 16971.

Fornaro, L and F Romei (2022b), “Energy shocks in the global economy”, forthcoming.

Forbes, K, J Gagnon and C Collins (2021), “Pandemic inflation and nonlinear, global Phillips curves”,, 21 December.

Guerrieri, V, G Lorenzoni, L Straub and I Werning (2020), “Viral recessions: lack of demand during the coronavirus crisis”,, 6 May.

Guerrieri, V, G Lorenzoni, L Straub and I Werning (2021), “Monetary policy in times of structural reallocation”, University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2021-111.

Olivera, JH (1964), “On structural inflation and Latin American ‘structuralism'”, Oxford Economic Papers321-332.

Tobin, J (1972), “Inflation and Unemployment”, American Economic Review 62(1): 1–18.


1 Guerrieri et al. (2020) highlight the role of demand complementarities in different sectors during the Covid-19 pandemic.

2 In the model, inflation imposes a loss of direct utility on agents. This aims to capture a variety of costs associated with high inflation, such as unwanted redistribution among individuals or the risk of the economy losing its nominal peg.

3 This idea underlies Keynes’ plan of 1941, which included sanctions for countries in persistent surplus. In Fornaro and Romei (2019), we formalized this idea and argued that these dynamics were likely at play in the decade following the 2008 financial crisis.