At Employ America, we have argued that shortages of physical productive capacity played a major role in the inflation seen during and after the recovery from the pandemic recession. In order to analyze the impacts of shortages and their resolution, we have been tracking reported shortages and comparing them to indices of industrial production and prices faced by producers. How the path of investment and production evolves after a period of reported shortages is likely to be highly suggestive for the path of a number of other important economic dynamics, most especially the labor market and increasingly relevant energy transition dynamics.
The top-level picture here is of an economy that is slowing down, but still growing. The problem is, that is the picture the Fed is looking for on the Demand side, and we are looking at the Supply side. We have repeatedly warned that by hiking rates sharply, the Fed risks sacrificing an opportunity for elevated demand to incentivize increased capacity. However, the industrial production numbers for this month do suggest that the slowdown the Fed has been looking for may be beginning to show up in the data. Combined with recent developments suggestive of possible mild deterioration in the labor market, the Fed should remain watchful that excessively tight policy does not inhibit a supply response to the past years’ inflation.