Are Supply Constraints Becoming Less of an Influence?

Posted by Jeffrey J. Roach, PhD, Chief Economist

Friday, July 15, 2022

Supply-Driven Contributions to Inflation

You have heard it here many times that the current inflationary environment has been irritated by supply-related problems with ports, international manufacturing shutdowns, and global shipping as primary challenges. And indeed, these have been major factors in inventory management. For example, auto manufacturers are still hampered with ready access to necessary components. As shown in the LPL Chart of the Day, inflation surprised markets with an accelerated inflation print this week, although the more comprehensive metric of inflation, the Personal Consumption Expenditure (PCE) deflator may not be as hot. The PCE deflator for June will be published on July 29.

View enlarged chart.

For the past year, supply-related problems contributed more to inflation than demand-related imbalances as shown in the gray box in the chart below. China’s zero-COVID policy was one of the biggest glitches in supply chains as metro areas and ports were shuttered by the Chinese government. However, things may be on the verge of changing. In May, the latest data point for the PCE, demand-driven contribution to inflation was slightly higher than the supply-driven contribution. This is an important development because the Fed’s monetary policy tools do not work on supply shocks but rather, only on demand.

View enlarged chart.

Good News for the Federal Reserve

The good news is that inflation may become more demand-driven and less supply-driven. This is positive for policy makers because monetary policy tools are now more relevant than they were when inflation was primarily from supply bottlenecks. So as supply constraints ease and as Fed tools become more impactful, we could see the rate of inflation decelerating in the latter half of this year.

For more on the current environment, be sure to watch our latest Econ Market Minute, where LPL Financial Chief Economist discusses more about the current state of affairs.


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