Inflation implies global growth

A key feature of the ongoing recovery from the Covid-19 recession is its unbalanced nature. Across the world, product demand is strong, while demand for communication-intensive services is declining (Figure 1). Considering that products are usually traded in countries, although not most services, the world economy is effectively moving away from non-commercial services and experiencing a large redistribution of demand for trade goods. Surprisingly, this period of exceptionally high global demand for products is associated with rising commodity prices and pressure on the global supply chain (Eo et al. 2022).

Figure 1 Products and services share total consumption costs

Note:See Fornaro and Romei (2022a) for information sources.

In a recent study (Fornaro and Romei 2022a), we propose a multi-country Keynesian model with multiple sectors to understand the macroeconomic impact of this unusual demand pattern. Our analysis revolves around three questions: What is the response to optimal monetary policy for redistributing global demand for products from services? How are international spillovers shaping the global recovery and inflation outlook? Is there any benefit from international cooperation?

Monetary policy and the structural perspective of inflation

We study a world consisting of countries that produce tradeable goods and non-tradeable services. Nominal wages are inflexible, so that monetary policy has a real effect, and weak demand can lead to unintended unemployment. We consider a global redistribution shock, that is, a temporary increase in consumer demand for service-oriented products, leading to an increase in the share of similar consumption expenditures of products observed during an epidemic.

Our first insight is that this redistribution of demand for goods from services could push the world economy towards stagnation. Intuitively, low demand induced companies in the service sector to reduce their workforce production and fire share. To stem the tide of unemployment, it is necessary to increase inflation in the business sector. On the one hand, higher prices motivate companies in the product sector to hire more workers and increase productivity. Moreover, as workers earn more from the commercial sector, the demand for their services increases.1 Through the impact of this income, higher product prices also increase employment in the service sector.

Optimal monetary policy cuts costs arising from high inflation as opposed to employment gains.2 A redistribution shock thus 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 redistribute workers across different sectors. This literature, however, focuses primarily on the closed economy, while we are interested in its international impact.

Capital flows, trade imbalances, and inflation spillovers

In a financially integrated world, a country can increase its use of business products by borrowing from the rest of the world and by running trade deficits. In fact, in our model, the regions that experience the strongest growth in demand for commercial products are able to adjust their trade deficits to the rest of the world. This helps explain why the U.S. trade balance deteriorated during the recovery from the Covid-19 recession, as the increase in commodity consumption in the United States has been particularly pronounced.

However, the trade deficit caused international inflation. When a country runs a trade deficit, it widens the trade deficit in the world market and worsens the trade barrier between inflation and employment in the rest of the world. Through this channel, a country faces increasing demand for tradeable goods by exporting high inflation abroad.

Our work thus formalizes the notion that global factors are playing a significant role in the recent rise in inflation, which is essentially synchronized between advanced economies (Forbes et al. 2021). It also warns against using the inflation differential to measure the strength of relative demand between the US and the euro area. The reason is that high commodity demand in the United States, and associated trade imbalances, also increase inflation in the eurozone. A more complete approach to understanding the difference in demand should thus look at the combination of inflation and trade imbalance.

Free riding and profit from monetary policy cooperation

We also highlight the existence of a free riding problem among national central banks, when global demand for tradable goods is exceptionally high. When a country implements a financial expansion, it stimulates the production of its commercial products and increases its net exports to the rest of the world, thus reducing the pressure on the world market for tradeable goods. As consumers around the world gain access to a wider supply of tradable goods, their demand for non-commercial services increases. Through this channel, a financial expansion increases the overall demand and employment not only internally but also in other parts of the world.

The presence of this international aggregate demand spillover suggests that national central banks are likely to fall into a coordination trap. The reason is simple. Inflationary costs related to financial expansion are borne entirely by domestic agents. Profits in terms of high demand and employment, in turn, are partially enjoyed by the rest of the world. The National Monetary Authority has thus given an incentive to travel freely in foreign financial expansion, which means that the lack of international cooperation can lead to excessive unemployment during periods of exceptionally high demand for business products.

This result is compounded by the controversy over international outreach caused by large trade surpluses. A long tradition argues that current account surpluses are detrimental when global demand is lacking, as they export abroad to weaken domestic demand.3 But we show that when global demand for tradable products is high, things are very different when it comes to recovering from the Covid-19 recession. In this case, the policies that encourage domestic production of commodities – and current account surpluses – ease the pressure on world commodity markets, and act as a benign disruptive force in the rest of the world. These considerations suggest that current account surpluses should be discouraged when global demand is weak but should be encouraged when there is a weakness in global supply. Of course, this makes it a difficult task to design a system to control international trade imbalances.

The push for power in the world economy

Global energy prices are rising sharply, partly due to Russia’s aggression in Ukraine. In the ongoing work (Fornaro and Romei 2022b), we show that the increase in the price of energy increases all the static energy described above. High energy prices, in fact, increase the cost of production for manufacturing companies, leading to a shortage of tradable goods worldwide. As discussed above, when there is a shortage of business products, central banks face a barrier between inflation and employment, trade deficits push inflationary spirals to the rest of the world, and fiscal expansion creates a spillover of positive demand in foreign countries. The main difference is that in this case the euro area, due to its reliance on Russian power, may be the most affected region, meaning that the ECB may face particularly tough trade closures between maintaining inflation and maintaining economic activity.


Eo, Y, L Uzeda, and B Wong (2022) “Commodity inflation may be short-lived, but long-term inflationary risks remain”,, April 29.

Fornaro, L and F Romei (2019), “The Paradox of Global Thrift”, American Economic Review 109 (11): 3745-79.

Fornaro, L and F Romei (2022a), “Indian Monetary Policy in the Imbalance of Recovery”, CEPR Debate 16971.

Fornaro, L and F Romei (2022b), “The Impact of Power on the World Economy”, forthcoming.

Forbes, K, J Gagnon, and C Collins (2021), “Epidemic Inflation and Nonlinear, Global Phillips Curves”,, 21 December.

Guerrieri, V, G Lorenzoni, L. Straub, and I Werning (2020), “Viral Recession: Lack of Demand during Coronavirus Crisis”,, 6 May.

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

Oliveira, J. H. (1964), “On Structural Inflation and the 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) Emphasize the role of demand fulfillment in various sectors during the Covid-19 epidemic.

In model 2, inflation imposes utility losses directly on agents. It is meant to capture the various costs associated with high inflation, such as unwanted redistribution among individuals, or the risk of the economy losing its nominal anchor.

3 This idea is implicit in the 1941 Keynes Plan, which planned penalties for countries with persistent surpluses. Fornaro and Romei (2019), we formally adapted this insight and argued that these dynamics were probably effective in the decade following the 2008 financial crisis.

Leave a Reply

Your email address will not be published.