In our previous discussion, we examined significant global elements influencing the persistent trends in headline consumer price index (CPI) inflation, both in the U.S. and internationally. We defined these elements as Global Inflation Trend (GIT), Core Goods Global Inflation Trend (CG-GIT), and Food & Energy Global Inflation Trend (FE-GIT). This follow-up delves into the catalysts behind these trends, focusing on the tension between monetary policy responses to supply versus demand shocks.
The roots of rising global inflation can be attributed to various interrelated factors. Global shocks, such as the COVID-19 pandemic or simultaneous tightening of monetary policy, have markedly affected inflation across borders. Additionally, shocks originating from countries with substantial influence on global finance or trade—like the post-2008 financial crisis—have contributed to common trends. By distinguishing these shocks, we aim to illustrate their impacts systematically.
Using a structural vector autoregression (VAR) model, we integrate global inflation trends with economic activity indicators and the New York Fed’s Global Supply Chain Pressure Index. This approach allows us to differentiate between supply and demand shocks in the aftermath of the pandemic. Adverse supply shocks impose restrictions on inflation and supply chains, causing declines in global output, while demand shocks typically drive down both inflation and output.
Analyzing data from January 2020 onward, it’s evident that global supply shocks have heavily influenced the GIT until early 2023. Although demand was a drag in 2020, its contribution to inflation trends has diminished since 2021. Instead, robust global demand now accounts for the stagnation in inflation reductions observed from mid-2023 onwards, illustrating a complex interplay of economic factors.
Considering a hypothetical scenario where central banks aggressively countered demand shock contributions, our analysis projects a sharp decrease in global output. This would have likely intensified economic contraction without achieving substantial inflation reduction. Exploring this relationship further in the tradable goods markets reveals that supply shocks have consistently driven inflation trends, underlining their dominant role in the current economic landscape.
Ultimately, our findings emphasise the predominance of adverse supply shocks in shaping global inflation since the pandemic’s onset. These shocks reveal the difficult trade-offs faced by monetary policymakers, balancing price stability against economic growth. While rising global demand has stalled disinflation efforts since mid-2023, the substantial supply shocks necessitate policy caution, as they could exacerbate inflation without simultaneous growth benefits.
This article explores global inflation trends, highlighting the roles of supply and demand shocks since the pandemic. It categorises shocks affecting monetary policy into those inducing trade-offs and those that do not, revealing that most inflationary pressure stems from supply-side disruptions. Recent elevated global demand has impeded disinflation efforts, posing risks for policymakers in managing economic stability and inflation.
In summary, the intricate dynamics of global inflation since the pandemic are largely influenced by supply shocks, with the resultant trade-offs posing challenges for monetary policy. Sustained demand has recently stalled inflation deceleration; however, the dramatic impact of prior supply chain disruptions continues to overshadow these effects. Policymakers must navigate these contradictions carefully, balancing growth against the imperative of price stability in an uncertain economic landscape.
Original Source: libertystreeteconomics.newyorkfed.org
