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Services vs Goods Inflation: Why They Move Differently and What That Means

From 2020 to 2023, goods and services inflation moved in remarkably different patterns, creating distinct inflation dynamics that confused many observers. During the pandemic, goods inflation surged as supply-chain disruptions raised manufacturing and shipping costs. Services inflation remained moderate. Then from 2022 onward, goods inflation moderated sharply while services inflation accelerated and became persistent. Understanding why goods and services inflation diverge is crucial for interpreting inflation data and predicting monetary policy. The divergence reveals fundamental differences in how these sectors respond to economic shocks, how pricing power functions in each sector, and what economic pressures drive their inflation dynamics.

Quick definition: Goods inflation measures price increases for tangible products (food, clothing, appliances, electronics), while services inflation measures price increases for intangible services (haircuts, medical care, entertainment, transportation).

Key Takeaways​

  • Goods and services are fundamentally different: goods can be inventoried, imported, and substituted; services cannot be easily substituted or imported
  • Goods inflation is more volatile because it is driven by supply-chain disruptions and global commodity prices, which can spike and reverse rapidly
  • Services inflation is more persistent because it is labor-intensive and driven by wage growth, which is sticky and does not decline as easily
  • Goods inflation surged from 2021–2022 due to supply-chain disruptions from COVID-19 and manufacturing shutdowns, then fell sharply as supply normalized
  • Services inflation accelerated from 2022–2023 as labor costs rose and wage growth remained elevated
  • The split between goods and services determines where inflation is coming from and whether it is likely to persist
  • Different Federal Reserve policies are appropriate for goods versus services inflation: goods inflation often requires supply-side fixes while services inflation requires demand management
  • From 2023 onward, services inflation has become the primary inflation concern for policymakers

What Are Goods and Services?​

The distinction between goods and services might seem obvious, but understanding how they are categorized in inflation data is important.

Goods include all tangible, physical products:

  • Food and beverages
  • Clothing and footwear
  • Household furnishings
  • Appliances and electronics
  • Automobiles and vehicle parts
  • Gasoline and energy commodities
  • Tools and equipment

Goods can be manufactured in one place and shipped to another. They can be stored in inventory. They can be sold repeatedly (as used goods). They are subject to global competition, which tends to limit price increases.

Services include all intangible, non-physical outputs:

  • Healthcare (doctor visits, hospital care, prescription drugs)
  • Shelter and utilities
  • Transportation services (taxis, airlines)
  • Entertainment (movie theaters, streaming, concerts)
  • Haircuts and personal care
  • Repairs and maintenance
  • Education and childcare
  • Financial services

Services are produced where they are consumed. You cannot manufacture a haircut in China and ship it to the United States. You cannot inventory a medical procedure. Services are therefore subject to local labor markets and local competition, which gives service providers more pricing power.

The Structural Differences That Drive Divergence​

Goods and services move differently in inflation data because they are structurally very different in how they are produced and priced.

Supply constraints. Goods are subject to supply constraints primarily in the short term. A shortage of semiconductors can push computer prices up for months until supply is restored. But supply can be restored by increasing production or by importing from alternative sources. Services, by contrast, face persistent supply constraints based on labor availability. If there are not enough nurses, hospital services cannot be ramped up quickly—you cannot import nurses from overseas easily due to licensing and visa requirements. This makes services inflation stickier than goods inflation.

Pricing power and competition. Goods compete in global markets. A manufacturer in the United States competes with manufacturers in Vietnam, Mexico, and India. If U.S. prices for textiles rise, imports of cheaper textiles will increase, suppressing U.S. price growth. This global competition limits pricing power for goods manufacturers.

Services compete primarily in local markets. Your local hair salon competes with other local salons, not with salons in India. Similarly, healthcare providers in your region compete with other regional providers. This local competition gives service providers more pricing power and allows them to raise prices more freely.

Labor intensity. Services are more labor-intensive than many goods. A manufacturing plant might have equipment produce goods with minimal human labor. A hospital or salon, by contrast, requires workers to directly provide the service. Labor costs are therefore a larger share of service providers' total costs. When wages rise, service providers must raise prices to maintain margins. Goods manufacturers can often absorb wage increases through automation or improved efficiency.

Wage growth transmission. When wages rise, service workers (nurses, hairdressers, wait staff) demand higher pay. Service providers must raise prices to maintain profitability. Goods manufacturers, by contrast, can adjust to wage increases through automation, process improvements, or by accepting lower margins (especially if facing global competition). This explains why services inflation is more sensitive to wage growth than goods inflation.

The 2021–2023 Inflation Split: A Case Study​

The divergence between goods and services inflation from 2021 to 2023 provides a clear illustration of these dynamics.

2021: Goods surge, services moderate. In 2021, goods inflation surged to 9.9% year-over-year while services inflation remained at 1.9%. This massive divergence was driven by:

  • Supply-chain disruptions: The pandemic had disrupted manufacturing and shipping globally. Semiconductors were in short supply, pushing computer and automobile prices up sharply. Shipping costs surged (a container from China to the U.S. that normally cost $3,000 was costing $15,000). These cost increases were passed to consumers in the form of higher goods prices.

  • Demand for goods: Stimulus payments and remote work drove households to purchase goods—home office equipment, appliances, athletic equipment. This demand surge met constrained supply, pushing prices up.

  • Modest services demand: Services were still constrained by COVID-19 restrictions. Restaurants, hair salons, and entertainment venues were operating at reduced capacity or closed. Demand for services remained weak, keeping services inflation moderate.

2022: Goods moderate, services accelerate. By 2022, the pattern had reversed. Goods inflation fell sharply—from 9.9% in 2021 to 1.5% by late 2022—while services inflation accelerated, rising from 1.9% to 4–5%. This reversal was driven by:

  • Supply normalization: Supply chains began normalizing. Shipping costs fell back toward normal levels. Semiconductor supply improved. As supply increased, goods price growth slowed dramatically.

  • Goods demand softening: As goods prices rose and households shifted spending back toward services, goods demand weakened relative to supply, pushing goods inflation toward deflation.

  • Wages and services: Wage growth accelerated as tight labor markets pushed up compensation. Service providers raised prices to match higher labor costs. Additionally, as COVID restrictions fully lifted, demand for services (restaurants, haircuts, entertainment) surged, supporting services price growth.

  • Services supply constraints: While goods supply normalized, services labor supply did not. Hospitality workers, healthcare workers, and childcare providers remained in short supply, allowing services providers to raise prices.

2023: Goods deflation, services persistence. In 2023, goods inflation turned negative in many months—prices for goods were actually falling. Yet services inflation remained elevated at 3–4% annually. This divergence continued to reflect:

  • Goods oversupply: With supply chains fully normalized and demand softening, goods producers faced excess inventory and price competition. Appliance makers, clothing manufacturers, and automotive suppliers all cut prices to clear inventory.

  • Services wage growth: Despite slowing labor market growth, wage growth for service-sector workers remained elevated due to cumulative raises from prior years and tight labor markets in key sectors like healthcare. This continued upward wage pressure translated to services inflation.

  • Shelter persistence: Shelter, which represents about 28% of services inflation in the CPI, remained elevated due to the lags described in the previous article. Even as rent growth slowed in the market, shelter CPI inflation remained 5–7%.

The Composition of Inflation and What It Reveals​

The split between goods and services inflation tells a story about where inflation is coming from and what kind of economic pressures are present.

When goods inflation exceeds services inflation: This suggests that supply-chain or commodity shocks are driving inflation. It is often temporary and self-correcting as supply normalizes. This was the pattern in 2021–2022. The appropriate policy response is patience and supply-side measures (fixing supply chains, reducing regulatory barriers to production), not demand suppression.

When services inflation exceeds goods inflation: This suggests that labor market tightness and wage pressures are driving inflation. It is more persistent because wage growth does not quickly reverse. This is the pattern from 2022 onward. The appropriate policy response is demand management through higher interest rates to cool labor demand.

When both are elevated: This suggests broad-based inflation that is difficult to address through policy. It suggests both supply constraints (pushing goods inflation) and demand pressure (pushing services inflation). This is the most challenging inflation scenario and was experienced in 2021–2022.

When both are moderate: This suggests a well-functioning economy with supply adequate to meet demand and wage growth moderate. This is the desired condition for the Federal Reserve.

Why Goods Inflation Is More Volatile​

Goods inflation spikes and reverses more quickly than services inflation for fundamental reasons.

Supply can adjust quickly. When goods prices spike due to supply shortages, producers can respond by increasing production or by importing from alternative sources. Within months to a year, supply typically responds to the price signal, and prices moderate or fall. Semiconductor prices spiked in 2021, peaked, then fell sharply by 2023. Oil prices spiked to $147 in 2008, then fell to $30 within months as demand destroyed itself. Goods markets are price-elastic: when prices rise, demand falls and supply rises, driving prices back down.

Commodity prices are global. Goods prices are significantly influenced by global commodity prices. Oil, grain, metals, and other commodities are traded globally, so supply-and-demand imbalances affect prices worldwide. When OPEC cuts oil production, oil prices spike globally. When this happens suddenly, goods inflation spikes. When supply recovers or demand falls, prices reverse.

Inventories and imports buffer price changes. When goods prices rise, demand typically shifts toward lower-priced imports or toward inventory from prior periods. This import competition and inventory availability buffer against sustained price increases. Services have no such buffer—you cannot import a haircut or substitute a nurse visit with an inventory item.

Why Services Inflation Is More Persistent​

Services inflation is more persistent and stickier than goods inflation for equally fundamental reasons.

Labor supply adjusts slowly. When services prices rise due to labor cost increases, service providers cannot quickly increase labor supply. It takes years to train new nurses, teachers, or engineers. While goods shortages often resolve within a year or two, labor supply shortages persist for years. This makes services inflation more persistent.

Wages are sticky downward. Wages rarely fall in nominal terms—employers do not cut wages even when demand for their services falls. This downward stickiness in wages makes services inflation more persistent than goods inflation. Once wages rise due to tight labor markets, they remain elevated even if labor markets cool.

Pricing power is strong. Service providers have local monopolies in many cases. A person needing medical care cannot simply not buy medical services; they must seek care in their local market. Similarly, renters cannot easily substitute to alternative housing in distant markets. This local pricing power allows service providers to maintain or increase prices even when overall demand is weak.

Wage expectations and persistence. Workers in service sectors have experienced sustained wage growth. They now expect continued wage growth. Employers expecting that workers will demand higher wages in the future adjust their pricing upward in advance. This forward-looking behavior creates inertia in services inflation.

Real-World Examples of Goods vs. Services Divergence​

The 2008 financial crisis. Goods inflation (particularly energy) fell sharply from late 2008 to early 2009 as demand collapsed. However, services inflation remained more stable, declining less sharply. This divergence correctly signaled that the crisis was severe on the goods side but less severe on the labor market side initially. As the crisis deepened, services inflation eventually fell, but the lag was measurable.

The 2011 commodity spike. Oil prices spiked from $80 to $110, driven by Middle East tensions and supply concerns. Goods inflation, particularly energy and food, spiked. However, services inflation remained moderate. Within months, oil prices fell back to $80, and goods inflation moderated. Services inflation throughout remained moderate, correctly signaling that the spike was temporary.

The 2021–2023 pandemic divergence. This divergence was more dramatic than any in recent history. Goods inflation reached double digits; services inflation remained single digits. Then the reversal occurred, with goods deflation and services inflation becoming the dominant concern. This divergence revealed the distinct dynamics of supply-chain shocks versus labor market pressures.

The Policy Implications​

The goods-versus-services inflation split has important implications for monetary and fiscal policy.

Federal Reserve policy. The Federal Reserve focuses its interest-rate policy on controlling demand. Higher interest rates cool both goods and services demand, but goods inflation is often driven by supply shocks unresponsive to rate changes. If goods inflation is driving overall inflation, raising rates aggressively may cool the economy unnecessarily without controlling goods inflation. The Fed's 2022 decision to raise rates aggressively reflected a judgment that services inflation and broad-based demand pressure justified tightening, not just goods supply-shock inflation.

Supply-side policy. Goods inflation often benefits from supply-side policy: fixing supply chains, reducing tariffs on imports, streamlining regulations that slow production. These policies address goods inflation without requiring demand suppression. The Biden administration's focus on reducing supply-chain frictions was an implicit recognition that goods inflation had a supply-side component.

Labor-market policy. Services inflation benefits from labor-supply policies: immigration reform to increase labor supply, training programs to build skills, deregulation to allow service providers to operate more efficiently. These policies increase labor supply without requiring demand suppression.

Common Mistakes in Interpreting Goods vs. Services Inflation​

Mistake 1: Assuming the goods-services split is permanent. The dynamics can shift. If goods demand surges again and supply is constrained, goods inflation can accelerate. If services labor supply increases (through immigration or other means), services inflation can moderate. The split is informative about current conditions, not a law of nature.

Mistake 2: Believing services inflation is always more important. While services inflation has been more persistent from 2022 onward, goods inflation can be devastating when it spikes. If goods inflation surges due to geopolitical disruptions or climate shocks, it quickly becomes the dominant inflation concern.

Mistake 3: Thinking goods deflation is always good. Goods deflation—falling goods prices—can be good for consumers who benefit from lower prices. However, widespread goods deflation can signal weak demand and economic weakness, which can eventually flow through to services and broader economic trouble.

Mistake 4: Assuming service workers can substitute to goods-producing jobs. When goods inflation falls and services inflation rises, the sectors experience opposite dynamics. Goods-sector employment may fall while services-sector employment grows. Workers displaced from goods production cannot quickly move to services jobs due to skill mismatches and geographic differences.

Mistake 5: Ignoring shelter's role in services inflation. Shelter is now the dominant component of services inflation. Understanding goods versus services inflation without focusing on shelter divergence is incomplete.

FAQ​

How much of the inflation do goods and services each represent?​

In the Consumer Price Index, goods represent roughly 35–40% and services represent roughly 60–65%. However, shelter (which is technically a service) represents about 30% of the total CPI, meaning non-shelter services represent 30–35% and goods represent 35–40%. This split means that the Fed cannot ignore either component.

Can service prices ever fall?​

Yes, though it is less common than goods prices falling. During the 2008 crisis and again during the COVID-19 shutdown, some services prices fell as demand collapsed and providers had excess capacity. However, service price declines are rarer than goods price declines.

Why don't service prices respond to imports the way goods prices do?​

Because most services cannot be imported effectively. A haircut must be delivered locally. Medical care must be received locally. Entertainment can be imported (streaming services), but most services are inherently local. This local nature of services limits import competition and gives service providers more pricing power.

Is wage growth the same as services inflation?​

Not quite, but wage growth is a primary driver of services inflation. If wages grow 5% and service productivity grows 2%, services prices should rise roughly 3%. Wage growth puts upward pressure on services inflation, but it is not the only factor.

Will services inflation eventually fall to 2% like the Federal Reserve's target?​

Eventually yes, but the timeline is uncertain. Services inflation is currently (2024) at 3–4%, above the Fed's target. For it to fall to 2%, either wage growth must slow significantly or service-sector productivity must accelerate. Both would take time to occur.

How does shelter inflation factor into the goods-services split?​

Shelter is the largest component of services inflation, representing about half of it. Shelter inflation is particularly sticky due to the lags described in the prior article. This means services inflation is more persistent partly because shelter inflation is so persistent.

Explore these interconnected topics to deepen your understanding of sector-specific inflation:

Summary​

Goods and services inflation diverge significantly because they are fundamentally different in their production, competition, and pricing dynamics. Goods can be globally produced, inventoried, and substituted; they therefore face global competition and volatile prices that respond quickly to supply-and-demand imbalances. Services are locally produced and consumed, face local competition, and are labor-intensive; they therefore have more pricing power and sticky inflation that persists longer. From 2021 to 2023, goods inflation surged due to supply-chain disruptions then fell sharply as supply normalized. Services inflation remained moderate in 2021 then accelerated from 2022 onward as wages rose and labor supply constraints persisted. Understanding the split between goods and services inflation reveals what type of economic pressure is driving inflation—supply shocks (goods) or demand pressure (services)—and therefore what policies are most appropriate to address it. The Federal Reserve's 2022–2023 rate increases were justified partly by the persistence of services inflation even as goods inflation moderated, revealing that demand-side tightening was necessary to address wage and services inflation that supply-side policy alone could not fix.

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