For those who have followed my Twitter feed, you will know that I have long pointed out that "narrow vs broad-based," "transitory vs persistent," and "supply vs demand" are not three ways of saying the same thing. Narrow vs broad-based is a question of the selection of inflation components seeing outsized moves. Transitory vs persistent is a question of the duration of inflation. Supply vs demand is a question of the drivers of inflation. Conversations about these three dichotomies have too often compressed them together, when a more productive approach would be to look at the three independently. Just look at European inflation in 2022: a narrow supply shock to energy commodities broadened to non-energy goods and services components.
Input shortages – and the knock-on effects from those shortages – have been a major driver of inflation throughout the pandemic and post-pandemic recovery. This much is clear from the ISM Manufacturing Report: one of the most useful yet least-used parts of this survey over the past years has been the section on commodities that survey respondents mention to be in "short supply." In the December release of the report, electrical components were reported to be in shortage for 27 consecutive months! Electronic components and semiconductors were reported by manufacturers to be in short supply for 25 consecutive months! That's two full years in which physical input shortages have constrained production.
So what does this mean for us today? There have been three central debates about inflation that have been too easily conflated with one another, making a mess of the terms of each. They are:
- Narrow or Broad-Based
- Supply-Driven or Demand-Driven
- Transitory or Persistent
Yes, they may be related, but ultimately these are three independent axes for describing inflation. The binary framing— that the question is one of narrow-supply-transitory as a package vs broad-based-demand-driven-persistent as a package—misses a lot about the nature of economic shocks, and has actively hampered policymakers’ and commentators’ ability to provide effective analysis of the present situation.
The breadth of inflation is a cross-sectional fact about the distribution of price index changes within a given month. In lay terms, it is about how many components are seeing price increases. Few = narrow, many = broad. However, this is not actually a “debate” because we can simply look at trimmed-mean and weighted-median measures of CPI and PCE inflation. At any specific point in time, inflation can be either narrow or broad-based; it cannot be both. The only place for debate may be over the share of inflation components that need to be seeing price increases to declare the phenomenon “broad-based.”
The supply vs demand debate is ultimately a debate about causality. Debates about causality rarely come to broad and clear agreement even decades after the relevant episode has passed. Just look at the ways in which the inflationary experience of the 1970s gets routinely re-litigated. But two sets of causes need not be mutually exclusive. It’s possible to believe supply and demand are simultaneously exacerbating inflation, and it is possible to adequately describe economic dynamics using that belief.
The transitory vs persistent debate has been over the length of time inflationary dynamics will prove relevant in the absence of intervening policies and shocks. Ultimately, this is something we can only know with certainty once it is in the rearview mirror. But for Fed policymaking, the ex-ante judgment about this dynamic is key: will the effect on inflation last, or will it filter out on an acceptable timeline? Fed policies are blunt, involve collateral damage, and tend to affect inflation with a longer lag than they do financial conditions.
Only time will tell how these physical input shortages resolve. Yet, it's worth noting that this supply deficiency has been fairly persistent by most standard understandings of the term. These shortages have had a profound impact on the production and availability of automobiles in the United States, and set off price increases in a number of related services (insurance, maintenance & repair, rental, leasing). This "supply" driven impact nevertheless had a longer and broader inflationary impact than was appreciated at the onset of the bottleneck.
We are starting to see some progress in terms of automobile production and sales, and unsurprisingly some disinflation in automobile-related components in today's December 2022 CPI release. The pace of improvement in the inflation outlook will (partially) hinge on how much faster this bottleneck can ease over the coming months and quarters.