What Drives the Recent Surge in Inflation? The Historical Decomposition Roller Coaster

Thu, 01 Jan 2026 00:00:00 +0000

The paper addresses what drove the post-COVID inflation surge in the United States and internationally. Before answering the substantive question, the authors identify and diagnose a methodological obstacle: the standard tool used for such analysis — the historical shock decomposition in a structural VAR — can produce wildly inconsistent narratives depending on small, likelihood-inconsequential changes in the model’s parameters.

The mathematical core is the VAR decomposition of observed data into a deterministic component (DC, the model’s period-zero forecast in the absence of any realized shocks) and a stochastic component (SC, the discounted cumulative sum of shock contributions). Because DC and SC sum to data, imprecision in DC is mechanically transmitted to SC, making inferences about shock contributions unreliable. The authors establish that conditional likelihood-based estimation leaves the VAR constant C poorly identified: parameter perturbations that move the likelihood only negligibly can shift DC dramatically. This “excess volatility” in DC is distinct from the better-known overfitting problem: excess volatility is about cross-draw uncertainty in DC, not its average level, and can be severe even when overfitting is mild.

Drago Bergholt | Macro Paper Warehouse

What Drives the Recent Surge in Inflation? The Historical Decomposition Roller Coaster