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What drives inflation? Disentangling demand and supply factors

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  • Sandra Eickmeier
  • Boris Hofmann

Abstract

e estimate indicators of aggregate demand and supply conditions based on a structural factor model using a large number of inflation and real activity measures for the United States. We identify demand and supply factors by imposing theoretically motivated sign restrictions on factor loadings. The results provide a narrative of the evolution of the stance of demand and supply over the past five decades. The most recent factor estimates indicate that the inflation surge since mid-2021 has been driven by a combination of extraordinarily expansionary demand conditions and tight supply conditions. We obtain similar results for the euro area, but with a somewhat greater role for tight supply consistent with the greater exposure of the euro area to recent adverse global energy price shocks. We further find that tighter monetary policy and financial conditions dampen both demand and supply conditions.

Suggested Citation

  • Sandra Eickmeier & Boris Hofmann, 2022. "What drives inflation? Disentangling demand and supply factors," BIS Working Papers 1047, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1047
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    Cited by:

    1. Lilian Muchimba & Mimoza Shabani & Alexis Stenfors & Jan Toporowski, 2024. "Decomposing the Rate of Inflation: Price-Setting and Monetary Policy," Working Papers in Economics & Finance 2024-04, University of Portsmouth, Portsmouth Business School, Economics and Finance Subject Group.
    2. Speck, Christian, 2023. "Pricing the Bund term structure with linear regressions – without an observable short rate," Discussion Papers 08/2023, Deutsche Bundesbank.
    3. Serdar Kabaca & Kerem Tuzcuoglu, 2023. "Supply Drivers of US Inflation Since the COVID-19 Pandemic," Staff Working Papers 23-19, Bank of Canada.
    4. Clodomiro Ferreira & Stefano Pica, 2024. "Household perceptions of the sources of business cycle fluctuations: a tale of supply and demand," Temi di discussione (Economic working papers) 1441, Bank of Italy, Economic Research and International Relations Area.
    5. Todd E. Clark & Matthew V. Gordon, 2023. "The Impacts of Supply Chain Disruptions on Inflation," Economic Commentary, Federal Reserve Bank of Cleveland, vol. 2023(08), pages 1-8, May.
    6. Jean-Marie Le Page, 2024. "Pure Theories of Policy Mix: Nordhaus's Destructive Game and the Case of High Inflation," Post-Print hal-04634043, HAL.
    7. Matthew Read, 2024. "Sign Restrictions and Supply-demand Decompositions of Inflation," RBA Research Discussion Papers rdp2024-05, Reserve Bank of Australia.
    8. Solikin M. Juhro, 2023. "Future Central Banking In Emerging Market Economies," Working Papers WP/01/2023, Bank Indonesia.
    9. Clodomiro Ferreira & Stefano Pica, 2023. "Household Perceived Sources of Business Cycle Fluctuations: a Tale of Supply and Demand," Working Papers 287, Red Nacional de Investigadores en Economía (RedNIE).

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    More about this item

    Keywords

    inflation; aggregate demand and supply; factor model; sign restrictions; monetary policy.;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables

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