2022-18 | October 2022
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Decomposing Supply and Demand Driven Inflation
The extent to which either supply or demand factors drive inflation has important implications for economic policy. I propose a framework to decompose inflation into supply- and demand-driven components. I generate two new data series, the supply and demand-driven contributions to personal consumption expenditures (PCE) inflation, which quantify the degree to which either demand or supply is driving inflation in a current month. The series show expected time-series patterns. The demand-driven contribution tends to decline during recessions, while the supply-driven contribution tends to follow food and energy prices. Monetary policy tightening acts to reduce the demand-driven contribution of inflation. Oil-supply shocks act to increase the supply driven contribution, but decrease the demand-driven contribution of inflation. The decompositions can be used to test theory or by policymakers and practitioners to track inflation drivers in real time.
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Shapiro, Adam Hale. 2022. "Decomposing Supply and Demand Driven Inflation," Federal Reserve Bank of San Francisco Working Paper 2022-18. Available at https://doi.org/10.24148/wp2022-18