Supply chains and inflation

For the last year plus I have emphasized the role of extraordinary demand in disrupting supply. For example, here and here and here. This angle emerges from a perception that contemporary supply capacity is organized around — essentially emerges from — demand. A sudden shift in demand misaligned with capacity will inevitably disrupt flows. So, I look at the slope of US Personal Consumption Expenditures (including sub-components) since Spring 2021 and see a recurring cause of stock-outs, freight congestion, production gyrations, more hires, price increases, and related.

It is worth emphasizing, this blog focuses on Supply Chain Resilience. I am mostly concerned with how demand influences physical flows.

I confess to often treating even stubbornly constrained supplies as (usually, eventually, really) demand dependent. For example, I trace reduced supply of new vehicles to reduced supply of legacy semiconductors that, I argue, emerged from sharp declines in demand for new vehicles in spring 2020. Vehicle manufacturers slashed orders of semiconductors. Production capacity for semiconductors was shifted to other higher margin categories (suddenly in much higher demand). When demand for new vehicles surged several weeks later there was no longer sufficient production capacity to make and deliver the semiconductors needed.

Is this outcome supply-driven or demand-driven? Both for sure. But for what it’s worth, for me these specific swings in demand seem causal, while the resulting shortages are symptomatic. (To acknowledge supply driven possibilities: reduced wheat supplies resulting from Russia’s invasion of Ukraine are not demand-driven.)

Symptoms cannot be ignored. But I mostly want to understand and focus on causes.

Adam Hale Shapiro at the Federal Reserve Bank of San Francisco is as concerned with causes of inflation as I am concerned with how shifts in demand can cause supply complications. These are distinct, but related angles on our shared reality.

Yesterday Dr. Shapiro authored an Economic Letter which, “highlights that both supply and demand factors are responsible for current elevated inflation levels. Supply factors explain about half of the difference between current 12-month PCE inflation and pre-pandemic inflation levels, and the effects appear to be rising more recently. Demand factors are responsible for about a third of the difference, and those effects appear to be diminishing more recently. The remainder is due to factors that cannot be definitively labeled as supply or demand. The large impact of supply factors implies that inflationary pressures will not completely subside until labor shortages, production constraints, and shipping delays are resolved.”

Below is a visual break-down of how this analysis compares and contrasts the interplay of demand and supply factors on inflation.

Dr. Shapiro’s method is as fine-grained as my approach is superficial. I am not quite sure — yet — if his careful method offers insight on how demand influences physical supply. I need to read and think some more — when not as distracted as right now. If readers see promising connections, please let me know. It is, in any case, a constructive and provocative presentation worth your reading — before I swing in with my supply chain resilience bias

Contributions to annualized monthly changes in inflation