Supply and Demand-Driven inflation: Decomposition and policy implications

Kira Kang, Rodrigo Sekkel, Temel Taskin and Jing Yang

No 2026-33, Staff Analytical Papers from Bank of Canada

Abstract: This note decomposes Canadian inflation into supply- and demand-driven components using detailed personal consumption expenditure data. We find that both supply and demand forces contributed to the post-pandemic rise in inflation, with supply-side pressures accounting for the larger share. Demand-driven inflation is more cyclical and declines during economic downturns. We then use the decomposition in two policy applications. First, contractionary monetary policy shocks lower demand-driven inflation but have little effect on supply-driven inflation. Second, estimates of a targeted Taylor rule indicate that the Bank of Canada responds more strongly to demand-driven inflation than to supply-driven inflation. The results highlight the importance of distinguishing between the sources of inflation when evaluating inflationary pressures and monetary policy.

Keywords: Models and tools; Econometric, statistical and computational methods; Monetary policy; Inflation dynamics and pressures; Monetary policy framework and transmission (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Date: 2026-07
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocsap:26-33

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