Why inflation is dropping from highs and with little economic hardship

When inflation is a problem, the central bank raises interest rates. That causes some pain and lowers demand, and price pressures recede. That's what they teach in Central Banking 101.

The big picture: But it may not explain what has happened over the last year; inflation has fallen from over 9% at its peak last year to below 4%, with little economic hardship.

Why it matters: Understanding the reasons for the Great Disinflation underway is crucial to drawing lessons for the future. And new research suggests: It's the supply side, stupid.

State of play: A new paper finds that inflation has come down because of growth in the supply of goods and services rather than policymakers succeeding at crushing demand. It has crucial implications for whether the economy might avoid a recession.

• "The majority of disinflation has been driven by expanding supply rather than decreasing demand," writes Mike Konczal, the paper's author and a director at the Roosevelt Institute.
• "A combination of resolving supply shocks and a subtle decrease in demand has driven inflation down dramatically, with no cost to the level of employment," precisely what a "soft landing" would have predicted, Konczal adds.

Details: Konczal looked at price and quantity changes for core items (excluding food and energy) measured by the Personal Consumption Expenditure Price Index, and the dynamics of quantities and prices for each.

• The findings showed that a huge share of core categories (73%) and services (66%) "see prices falling with quantities increasing—a sign of expanding supply," the paper says.

Context: Central bank policy did not heal supply woes that helped slow inflation. But Fed chair Jerome Powell has suggested higher borrowing costs have helped cool price gains, alongside a normalizing supply chain.

• The auto sector might illustrate this best, Powell said in Jackson Hole last month: "As the pandemic and its effects have waned, production and inventories have grown, and supply has improved. At the same time, higher interest rates have weighed on demand."

Of note: The paper acknowledges evidence that "we are decreasing demand, but in such a way that just a small decrease in spending has an outsized impact on inflation" — a result of an overheated economy.

What they're saying: "This has been true over the last six months, but will it be true over the next year? Is it true enough to get us to something closer to 2% inflation on a sustained basis?" Konczal tells Axios.

• But Konczal says there is some reason for optimism: "There's an idea that 'the last mile is going to be the hardest.' That we did the easy disinflation first, and now it's going to be all hard. It seems like maybe it is going to be kind of similar all the way down."