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Decomposing Supply and Demand Driven Inflation

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  • Adam Hale Shapiro

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.

Suggested Citation

  • Adam Hale Shapiro, "undated". "Decomposing Supply and Demand Driven Inflation," RBA Annual Conference Papers acp2023-03, Reserve Bank of Australia, revised Nov 2023.
    • Handle: RePEc:rba:rbaacp:acp2023-03
    Note: Paper presented at the RBA's annual conference 'Inflation', Sydney, 25–26 September 2023.
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    File URL: https://www.rba.gov.au/publications/confs/2023/pdf/rba-conference-2023-shapiro.pdf
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    Keywords

    inflation; supply-demand decomposition; sign restrictions; structural VAR model;
    All these keywords.

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