Opinion: Supply-Side Inflation Doesn’t Fit the Facts


Inflation | Image by Cinemato

Prominent Democrats are doubling down on the supply-side inflation narrative. At the semiannual monetary-policy report to Congress, there was a concerted effort to portray ongoing inflation as beyond the Fed’s control. Supply-side inflation is possible, and in the early post-pandemic months, it was a reasonable concern. But the facts since then don’t fit the story. This is old-fashioned, demand-driven, monetary-policy-induced inflation — and the data prove it.

If supply problems were in the driver’s seat, we would observe rising prices and falling output. But only the first holds. Since the pandemic, real GDP has consistently increased. In the fourth quarter of 2022, it grew at a respectable annualized rate of 2.7 percent. The fact that prices and output are moving in the same direction is a dead giveaway that, whatever supply problems remain, demand expansion is contributing more to inflation.

The narrative of supply-side inflation implies that as supply constraints ease, we should see rising income growth and falling prices — outright deflation. Transportation bottlenecks and energy shocks temporarily cause prices to rise, but what goes up must come down. When the pressures ease, the general price level must fall. We’ve seen some disinflation in recent months, meaning a slowdown in the rate of inflation. But we’re still nowhere near a decline in the price level.

We also have independent confirmation that demand is high, and has been so for years. The best measure of economy-wide demand is nominal GDP: total output valued at current market prices. This was about $26 trillion in the last quarter of 2022. Estimates of the neutral level of NGDP, the maximum consistent with full employment of the economy’s scarce resources, was about $24.5 trillion. Total demand is between 3 percent and 8 percent above its trend level from before the pandemic. We’re definitely still in excess-demand territory.

Interest rates, a more conventional measure of demand, tell a similar story. The Fed’s preferred price index rose at an annualized rate of 7.2 percent last month. Using the current federal-funds-rate target of 4.75 percent, the inflation-adjusted rate is a negative 2.7 percent. That’s still easy money, which contributes to high demand. Most economists think the real federal funds rate (the nominal rate minus the inflation rate) consistent with a healthy market for bank reserves is 0.25 to 0.5 percent. The federal funds rate would need to rise from 7.45 to 7.7 percent to achieve this.

Inflation supply-siders have one final refuge: falling productivity growth. If the economy grows more slowly than total demand, prices may rise faster. Compared to pre-pandemic trends, average labor productivity is indeed down. But it hasn’t fallen enough to explain the bulk of inflation. At most, productivity problems explain about 2 percentage points of ongoing inflation. That means we’re left with a residual annualized inflation rate of 5.2 percent, which is more than double the Fed’s target.

We can’t beat inflation if we get its causes wrong. Supply problems were at work in the past and may linger still. But easy money is the main obstacle, and until we rein it in, the American economy will continue to suffer needlessly from inflation. Chairman Powell and the FOMC should stay the course until inflation is well and truly whipped, rather than conveniently blaming factors beyond their control.

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18 days ago

I agree. Inflation results with too much funny money being pumped into the system.
Because we have a debt-based monetary system, then ‘forever’, year after year, more money needs to be created in order to pay the interest on the debt.

Unfortunately, many people do not know the history of The Federal Reserve. If they did, they would be alarmed.
G. Edward Griffin‘s book: The Creature from Jekyll Island gives details of how The Federal Reserve was concocted by rich elite…and ‘coincidently’ the Federal Income Tax was enacted during that time period.

R Reason
R Reason
Reply to  ThisGuyisTom
6 days ago

People would “be alarmed” if they knew Griffin was a conspiracy theorist/fringe scientist and that his books, including this one, are mostly fiction.


18 days ago

Recorded May 14th-16, 2008 at the 44th Annual conference on Bank Structure and Competition hosted by the Federal Reserve of Chicago. Gary Franchi, Managing Editor of Republic Magazine, interviews Jerry Nelson, Corporate Communications for the Federal Reserve.

One of the questions which Gary Franchi asked was:
“People have often questioned about the Federal Reserve being a private bank or a private corporation.
 Is that in fact true?”
Jerry Nelson’s ANSWER: “It is. …We are literally owned by the banks in our district….”

Other QUOTES from Nelson
“…the insatiable foreign demand for our $100 dollar bills. They don’t use them as a medium of exchange overseas. They use them as a store of value. (countries listed)…”
“…a hundred dollar bill costs us 7 cents…in the interim, American commerce and industry doesn’t give them away. We are getting 100 dollars worth of something…Belgium chocolate, French wine…for something that costs us 7 cents. It is not a bad markup…They can have all they want. Almost none never comes back….”

Gary Franchi interviews Chicago Federal Reserve Bank’s Jerry Nelson (circa 2008)
(15 minutes)

18 days ago

IMHO There was initially a massive Supply Side Inflationary market during the Pandemic and while the trade blockades were in place as they started to ease corporations and big business everywhere saw opportunity for big price increases and now that they are reaping that profit they do not want to give it up. Frankly until they are forced we will pay higher prices across the board. There are two job openings for every person walking so lack of employees is off table, raw materials are moving albeit at a higher cost because the Fuel industry is making record profits by doing nothing except fighting their competition in Renewables. And yet they are some of the biggest investors in Renewables so they are playing both ends against the middle. Charging inflationary prices for oil and gas and investing it in their next money maker. Capitalism at its finest/worst. Healthcare is out of control as is big pharma. We have dropped so far in world rankings because of this we are 39th worldwide in Education, and every measured socio economic standard. Because that 50 Trillion that move from the bottom 90% tot he top 1% just isn’t enough

18 days ago

One problem is that GDP is based on sales DOLLAR, not widgets.

If one raises the price 35% and reduces the production, one could still achieve a rise in GDP. That is the fallacy.

If we look at the number of widgets sold we might have a completely different view. I can tell you that the wholesale price of copper is back to what it was pre pandemic. Yet the price of copper wired is still 250% higher than Trump days. I can probably go through 90% of building materials and show the same correlation. That is ONE industry.

One example is aluminum vented soffit. The price of aluminum is up about 20% from the baseline date. The price of the soffit at any box store is up 280%

While cost of shipping, wages, cost of energy to product is all up, the question is: Can a 20% raise across the board in these areas including raw material equate to a 280% rise in value of product?

With regard to “reducing inflation” a cry of he dems, it is not possible to reduce inflation at all. We therefore need to adjust tax levels and rates and deductions etc to match the inflation.

Example in FL the homestead exemption was $5000 in 1933. In 1983 it was raised to $25,000. IN todays money that is $100,000 and we have seen no adjustment, however the government gets to raise actual taxes up to 3% per year! The taxpayers are the losers, especially the elderly.