There’s a new 60/40 in the city and that’s a contribution to inflation from consumer demand for goods and pandemic-broken supply chains.

That’s according to a study by Julian DiGiovanni, who publishes on the NY Fed’s blog Liberty Street Economics. Over the summer, he raised an interesting question: How much have supply constraints pushed up US inflation?

Short answer: 40%.

The long answer is based on detailed research by FRBNY, ECB and Harvard. Most observers of economics assumed the answer to his question was “some amount,” but I believe Di Giovanni and his co-authors were the first to quantify it:

“Our analysis of the relative importance of supply-side versus demand-side factors shows that 60 percent of US inflation in the 2019-21 period was due to increased demand for goods while 40 percent was attributable to supply-side issues that magnified the impact of this higher demand.”

This raises the obvious question of what the 40% FOMC rate hike is going to do to fix supply-chain-related problems. Honest answer: “None, we are targeting 60% which is the demand side of the product

My job is not to give policy advice to the Fed, but to explain what they are doing and its potential impact on our portfolio. To paraphrase Ray Dalio, the investor’s role is to embrace reality and deal with it as it is.

Still, I can’t help but observe that the FOMC response to pandemic-induced inflation is blunt, excessive and unnecessarily painful for middle and lower economic earners.

The Fed can learn from the Hippocratic Oath: “First do no harm

They did damage by staying at the emergency level of zero for too long, and then missing the initial increase in inflation directly through their 2% target. Now, they are compensating massively by pushing the economy into recession.

Jerome Powell and the FOMC should ask themselves three questions:

1. How much of the supply chain problem is solving itself organically?
2. What fraction of demand is returning to the previous equilibrium between goods and services?
3. To what extent is the FOMC itself raising OER by making housing purchases unsustainable?

Bleeding, leeching, trepanation, and even mercury were forms of “medicine” used by doctors who had little understanding of how the human body worked and didn’t know what was really wrong with patients, but “harmed” them anyway. The Fed should learn from that ancient medical mistake.

Goof on.

see more:
Glenn Hubbard: Post-pandemic fiscal spending largely responsible for US inflation (FT, Nov 14, 2022)

Monetary Policy Challenges in a Fast Changing World (ECB Forum, June 2022)

How Much Has Supply Constraints Raised US Inflation? (Liberty Street Economics, August 24, 2022)

in the past:
What is Inflation: Labor or Capital? (November 7, 2022)

Behind the Curve, Part V (November 3, 2022)

When Your Only Tool Is a Hammer (November 1, 2022)

How the Fed Causes (Model) Inflation (October 25, 2022)

Why is the Fed always late to the party? (October 7, 2022)

Who’s to Blame for Inflation, 1-15 (June 28, 2022)

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