A brief email exchange with Adam Shapiro made me realize one
thing: Whether inflation is supply caused or not makes potentially a lot of
difference. Why? Because it could/should influence our thinking about the
future inflation outlook insofar as decrease supply might reverse itself eventually.
To see this consider the case of airline ticket prices in
euro zone I
discussed before. Accepting that the high prices in this segment are demand
driven but supply caused, and assuming that airlines will eventually re-learn
how to operate as efficiently as before the pandemic, then you would expect
prices to decrease significantly without a decline in demand. In other
words, this segment would feature deflation in absence of anything else. Including
action by the central bank, a quintessential transitory inflation. Hence, the
resulting outlook for inflation would be quite optimistic.
On the other hand, if the high prices are solely about demand
being too high relative to what was normal during the pandemic, then only decrease
in demand will help as supply simply cannot increase that far (at least not in
reasonable horizon). In this case prices/inflation will remain high as long as
demand is not brought back to its position. Hence, the resulting outlook for
inflation is very different: Assuming that there isn’t a recession, inflation
will prove sticky, and only through monetary policy demand management will we
force it back to target.
Therefore the distinction between driven/caused is important.
If it is demand caused, we inflation will be sticky. If it is supply caused
then we have hope for inflation to moderate, even if it currently is
demand driven inflation.
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