Inflationary and Deflationary Pressures: A Behavioral Decomposition of U.S. Inflation Dynamics

Quineche, Ricardo and Zapata, Juan (2025): Inflationary and Deflationary Pressures: A Behavioral Decomposition of U.S. Inflation Dynamics.

Abstract

This paper develops a novel behavioral decomposition of inflation as the net outcome of two competing forces: inflationary pressure, defined by the frequency and magnitude of price increases, and deflationary pressure, determined by corresponding price decreases. Using 245 PCE sub-indices spanning 1959-2024, we construct an exact bottom-up inflation measure that transparently maps sectoral price-setting behavior into macroeconomic aggregates. Our decomposition reveals fundamental asymmetries in inflation formation: inflationary pressure exhibits dramatic variation (2.35%-12.68%) while deflationary pressure remains remarkably stable (0.72%-5.18%), indicating inflation episodes are primarily driven by surges in upward pricing momentum rather than retreats of downward movements. Historical analysis shows distinct pressure regimes across major macroeconomic episodes: the Great Inflation featured extreme inflationary pressure volatility, the Great Moderation achieved balanced dynamics, the 2008-2009 crisis uniquely witnessed deflationary pressure dominance creating deflation risk, while COVID-19 saw dramatic inflationary pressure resurgence. We reassess the price puzzle using Bayesian local projections with alternative monetary policy shock identifications. Conventional narrative shocks generate sustained inflationary pressure increases with minimal deflationary response, while informationally robust shocks resolve the puzzle completely through both increased deflationary pressure and reduced inflationary pressure, with the deflationary channel providing the dominant contribution consistent with demand-channel transmission. Extensive robustness checks across specifications and estimation methods confirm these findings while revealing the diagnostic value of pressure decomposition for evaluating shock quality. Results demonstrate that the price puzzle reflects informational frictions rather than genuine economic phenomena, and suggest successful monetary policy operates through managing pressure balance with important implications for real-time policy diagnosis and central bank communication.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation decomposition, price puzzle, monetary policy transmission
• Subjects: C - Mathematical and Quantitative Methods > C4 - Econometric and Statistical Methods: Special Topics > C43 - Index Numbers and Aggregation; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies

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