Are the Demand and Supply Channels of Inflation Persistent? Evidence from a Novel Decomposition of PCE Inflation from Boston Federal Reserve Bank

The Boston Federal Reserve has published a study that categorizes inflation into four distinct types: persistent supply, transitory supply, transitory demand, and persistent demand. The author of this study has found that among these four types, transitory supply shocks have the most significant impact on short-term inflation, while persistent demand shocks exert the most influence on medium and long-term inflation.

Given these findings, it is crucial for the Federal Reserve to implement monetary policies that can effectively mitigate the effects of persistent demand shocks in order to control medium and long-term inflation. This may involve maintaining higher federal funds rates until the persistent demand shock subsides, despite calls from many investors for an earlier rate cut.

This approach underscores the Federal Reserve’s commitment to ensuring price stability and sustainable economic growth. While higher interest rates may be a cause for concern among some market participants, it is a necessary measure to temper persistent demand shocks and thereby keep inflation in check over the medium to long term.

Table 1: Top-Five Categories with Persistent Demand and Supply Shocks: June 2021 through June 2022

	Inflation Contribution (ppts)	Price Change (%)	Consumption Change (%)
Persistent supply
New light trucks	0.23	11.3	-10.3
Furniture	0.15	13.1	-6.8
Fuel oil	0.14	98.5	-29.0
Motor vehicle leasing	0.08	18.8	-20.0
Tobacco	0.05	7.9	-10.1
Persistent demand
Air transportation	0.17	29.8	25.0
Motor vehicle maintenance and repair	0.10	7.9	2.3
Hotels and motels	0.06	10.7	30.9
Alcohol in purchased meals	0.05	5.6	6.3
Hairdressing salons	0.02	6.3	9.4

Source: Author’s calculations based on U.S. Bureau of Economic Analysis data through June 2022.

The table above presents the top-five categories with persistent demand and supply shocks for the period of June 2021 through June 2022. It provides information on the inflation contribution (in percentage points), price change (in percentage), and consumption change (in percentage) for each category.

Under the category of persistent supply, the top-five categories are as follows:

1. New light trucks: It contributed 0.23 percentage points to inflation, experienced a price increase of 11.3%, and a decrease in consumption by 10.3%.
2. Furniture: It contributed 0.15 percentage points to inflation, saw a price increase of 13.1%, and a decrease in consumption by 6.8%.
3. Fuel oil: It contributed 0.14 percentage points to inflation, experienced a significant price increase of 98.5%, and a substantial decrease in consumption by 29.0%.
4. Motor vehicle leasing: It contributed 0.08 percentage points to inflation, had a price increase of 18.8%, and a decrease in consumption by 20.0%.
5. Tobacco: It contributed 0.05 percentage points to inflation, had a price increase of 7.9%, and a decrease in consumption by 10.1%.

On the other hand, under the category of persistent demand, the top-five categories are as follows:

1. Air transportation: It contributed 0.17 percentage points to inflation, experienced a significant price increase of 29.8%, and a substantial increase in consumption by 25.0%.
2. Motor vehicle maintenance and repair: It contributed 0.10 percentage points to inflation, had a price increase of 7.9%, and a slight increase in consumption by 2.3%.
3. Hotels and motels: It contributed 0.06 percentage points to inflation, had a price increase of 10.7%, and a significant increase in consumption by 30.9%.
4. Alcohol in purchased meals: It contributed 0.05 percentage points to inflation, had a price increase of 5

Source: https://www.bostonfed.org/publications/current-policy-perspectives/2022/are-the-demand-and-supply-channels-of-inflation-persistent.aspx

World Economic Outlook from IMF as of April 2023

The world economy experienced a robust growth rate of 3.9% during the period from 2005 to 2014, which remained relatively stable at around 3-4% until 2019. However, the outbreak of the COVID-19 pandemic caused a significant contraction, with a negative growth rate of -2.8% in 2020. Nevertheless, the global economy demonstrated remarkable resilience and exhibited a strong rebound with an impressive growth rate of 6.3% in 2021. This positive momentum carried into 2022, with a growth rate of 3.4%.

However, looking ahead, the world economy is expected to face a moderate deceleration in growth. Projections indicate a growth rate of 2.8% for 2023, reflecting a slightly slower pace compared to the immediate post-pandemic years. Furthermore, in the foreseeable future, the world economy is anticipated to grow at a rate of 3.0%, which, although still positive, represents a lower growth trajectory compared to the pre-pandemic period.

These projections suggest a more tempered expansion as the global economy adjusts to post-pandemic dynamics, such as evolving trade patterns, shifts in consumer behavior, and potential changes in fiscal and monetary policies. While the world economy has demonstrated resilience and recovery, the anticipated lower growth rates indicate the need for ongoing monitoring and adaptation to ensure sustained economic progress.

World:
The IMF projects a moderate growth trajectory for the global economy. The GDP growth rate was 3.9% during 2005–2014, and it remained relatively stable around 3-4% until 2019. However, the outbreak of the COVID-19 pandemic in 2020 resulted in a significant contraction, with a GDP growth rate of -2.8%. Nevertheless, the IMF forecasts a strong rebound in 2021, with a projected growth rate of 6.3%. Looking ahead, the growth rates are expected to stabilize around 2-3% in the coming years, with a projection of 3.0% for both 2023 and 2024.

Advanced Economies:
The advanced economies experienced a more modest growth pattern compared to the global average. The GDP growth rate during 2005–2014 was 1.5%, followed by moderate growth rates ranging from 1-2% until 2019. The COVID-19 pandemic had a significant impact, resulting in a contraction of -4.2% in 2020. However, the IMF anticipates a recovery in subsequent years, with a projected growth rate of 5.4% in 2021. The growth rates for advanced economies are expected to remain relatively modest, ranging from 1-2% in the forecasted years, with a projection of 1.8% for 2028.

United States:
The United States, as the world’s largest economy, displayed similar growth patterns to the advanced economies as a whole. The GDP growth rate for the United States during 2005–2014 was 1.6%, followed by moderate growth rates ranging from 1-3% until 2019. The impact of the COVID-19 pandemic was evident in a contraction of -2.8% in 2020. However, the IMF projects a robust recovery, with a growth rate of 5.9% in 2021. Looking ahead, the growth rates for the United States are projected to stabilize around 1-2% in the forecasted years, with a projection of 2.1% for 2028.

Euro Area:
The Euro Area, consisting of multiple European countries sharing the euro as a common currency, exhibited relatively lower growth rates compared to the global and advanced economy averages. The GDP growth rate during 2005–2014 was 0.8%, followed by moderate growth rates ranging from 1-3% until 2019. The impact of the COVID-19 pandemic was more pronounced in the Euro Area, resulting in a contraction of -6.1% in 2020. The IMF expects a recovery in subsequent years, with a projected growth rate of 5.4% in 2021. Looking ahead, the growth rates for the Euro Area are expected to stabilize around 1-3% in the forecasted years, with a projection of 1.4% for both 2023 and 2024.

Japan:
Japan’s GDP growth rates have been relatively lower compared to other advanced economies. The growth rate during 2005–2014 was 0.5%, followed by moderate growth rates ranging from 0-2% until 2019. The COVID-19 pandemic and other challenges resulted in a contraction of -4.3% in 2020. The IMF projects a modest recovery, with a growth rate of 2.1% in 2021. Looking ahead, the growth rates for Japan are expected to stabilize around 0-2% in the forecasted years, with a projection of 0.4% for 2028.

Other Advanced Economies:
Other advanced economies, not included in the specific country categories, generally exhibit growth rates similar to the global and advanced economy averages. The GDP growth rate during 2005–2014 was 2.6%, followed by moderate growth rates ranging from 1-3% until 2019. The impact of the COVID-19 pandemic was evident in a contraction of -4.1% in 2020. The IMF anticipates a recovery in subsequent years, with a growth rate of 5.8% in 2021. Looking ahead, the growth rates for other advanced economies are projected to stabilize around 1-3% in the forecasted years, with a projection of 2.0% for 2028.

Emerging Market and Developing Economies:
Emerging market and developing economies have generally displayed higher growth rates compared to advanced economies. The GDP growth rate during 2005–2014 was 6.1%, followed by moderate to high growth rates ranging from 3-5% until 2019. The COVID-19 pandemic had a significant impact, resulting in a contraction of -1.8% in 2020. The IMF expects a strong recovery in subsequent years, with a growth rate of 6.9% in 2021. Looking ahead, the growth rates for emerging market and developing economies are projected to stabilize around 3-4% in the forecasted years, with a projection of 3.9% for both 2023 and 2024.

It is important to note that these projections are subject to change based on various factors, including economic policies, global events, and unforeseen circumstances. The IMF’s outlook provides a valuable assessment of the expected GDP growth rates, serving as a reference for policymakers, economists, and businesses to understand and anticipate future economic trends.

Source: World Economic Outlook, April 2023: A Rocky Recovery (imf.org)