Sta Hungry Stay Foolish

Stay Hungry. Stay Foolish.

A blog by Leon Oudejans

Inflation: demand versus supply-side

Usually, inflation is caused by excess demand (eg, business, consumers). The common Central Bank policy is to reduce demand by raising interest rates. Generally, it takes time before a lower inflation becomes visible. A policy of reducing interest rates creates hyperinflation (eg, Turkey).

There is, however, another cause: supply-side inflation. “A damaged supply side necessarily causes inflation, all other things being equal” (The Mint-2022). The 2019-2022 pandemic, zero-Covid in China, and the 2022 Russian invasion of Ukraine created those damages in global supply.

“But when the entire supply side of an economy is damaged, there is insufficient supply of goods and services in general to meet demand. So there is inevitably a rise in the general price level. A damaged supply side necessarily causes inflation, all other things being equal.”

Quote from 2022 article: Inflation is a supply-side problem

Actually, I doubt that raising interest rates (ie, monetary economics) has any impact on supply-side inflation (ie, the real economy). Moreover, the opposite approach (ie, reducing interest rates to increase demand) hardly works anywhere. Lastly, negative interest rates were devastating (eg, pensions).

This quote appears to confirm my concern:

“However, because recent inflation was significantly caused by supply factors, the contractionary monetary policy put in place to curb it will entail real economic loss, especially for those most vulnerable in the labor market—people of color, workers without a college degree, disabled workers, and others.”

The Center for American Progress (CAP), 2022: Effective Inflation Control Requires Supply-Side Policy

CAP-2022: “There are several steps that could help in the short to medium term, including:

  • Expanding the uptake of COVID-19 vaccines to reduce labor and manufacturing supply shocks
  • Providing additional support for child and home care to raise labor force participation
  • Reducing limits on working-age immigration to increase labor supply
  • Intensifying antitrust enforcement to reduce the ability of corporations to raise prices more rapidly than costs
  • Increasing the supply of renewable energy and eliminating reliance on fossil fuels to limit energy supply shocks, including by implementing and building on the recently enacted Inflation Reduction Act”.

In my view, the above list (immediately) shows its limited relevance to supply-side inflation. Hence, my question: is there anything that can reduce supply-side inflation??

A cynical answer is “Yes” because inflation “solves” itself, considering the price elasticity of demand. At a certain price level, demand will (fully) stop. Suppliers want to avoid that moment. From a (mere) statistical point of view, price inflation will “decrease” once prices no longer increase.

A practical answer is “No” as consumer prices seldom go down, apart from (an increase in) rebate marketing. Hence, elevated prices are likely to stay, for business and consumers. This will create a wage-price spiral, and a “tit-for-tat inflation that makes everyone poorer” (ECB blog 30 March 2023).

I suppose we are stuck with supply-side inflation.

Stuck In The Middle With You (1972) by Stealers Wheel
band, lyrics, video, Wiki-band, Wiki-song

Note: all markings (bolditalicunderlining) by LO unless in quotes or stated otherwise.

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