Decomposing Supply and Demand Driven Inflation

Adam Hale Shapiro

RBA Annual Conference Papers from Reserve Bank of Australia

Abstract: 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 comsumption 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.

Keywords: inflation; supply-demand decomposition; sign restrictions; structural VAR model (search for similar items in EconPapers)
Date: 2023-11
New Economics Papers: this item is included in nep-mon
Note: Paper presented at the RBA's annual conference 'Inflation', Sydney, 25–26 September 2023.
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Persistent link: https://EconPapers.repec.org/RePEc:rba:rbaacp:acp2023-03

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