Supply chain disruptions are not a new threat, and they're not going away.
Globally, Covid-19 continues to jam supply chains. As a result, producers can't keep up with demand, pushing prices higher. Such inflation is not new and climate disasters could be 'The Big One.'
Programming Note: Today’s post is an in-depth answer to a reader question on “Ask Me Econ” yesterday. As promised, in addition, to short answers to each question there, I chose a question to write about in more detail today. It’s: “What is typically left unsaid when inflation is discussed.” Note my Q&A and follow-up post will soon be for paid subscriber only.
Supply chains are a hot topic now. It was clear from the very start of the pandemic that production shutdowns in China and Asia, especially in computer chips, would limit the supply of crucial inputs for many U.S. consumer goods.
In February 2020, Tracey Alloway and Joe Wiesenthal interviewed Dan Wang from China on the pending chip shortage. (If you aren’t already, you should be listening to their Odd Lots podcast.) That conversation was the first time I heard of the problem.
So why such a big deal? Global sourcing of production inputs, as well as many consumer goods, is a decades long trend. It affects the prices we pay at the store and generally it’s been good for consumers. This explainer from the St. Louis Fed in 2007 puts it well:
Support for free trade in many parts of the world, though still favorable, appears to have waned recently. This erosion may reflect rising uncertainties associated with job losses in industries that are exposed to international competition. It may also reflect a widening in the income distribution that has been associated with the rise of China, India and other fast-growing countries. On the flip side, imports of low-priced goods and services convey measurable benefits to consumers and companies, and multinational firms are responsible for a significant portion of the rising U.S. productivity growth over the past dozen years.
So, supply chains have contributed, in part, to low inflation for years in the United States and other countries. Consumers reaped the benefits, seen clearly in durable goods prices which up until Covid-19 mostly declined.
Note well, the Fed can’t do much to control supply-driven inflation, other than slamming on the breaks to lower demand. That’s true now and true in the past. Endless calls for the Fed to raise rates now due to temporary spikes in inflation largely driven by supply-chain disruptions are as frustrating as they are misguided.
It is clear, as I discussed recently, that we are seeing prices pressures from supply chains ease, such as with used car prices. (These prices skyrocketed earlier as new car production came to a screeching halt without computer chips and other inputs, at the same time that demand for cars surged.)
Tomorrow we get Consumer Price Index for August, and most professional forecasters expect monthly inflation to step down further, though remain higher than the pre-pandemic levels. We are not out of the woods with our supply chain issues, and we don’t want to solve this price problem with falling demand. That would be bad.
It’s also important to keep a historical perspective. Supply chain disruptions are not new, though today’s is more widespread than in the recent past. For example, the earthquake and tsunami that hit Japan in March 2011 disrupted supply chains and risked upward pressures on inflation, as noted by Mohamed A. El-Erian:
Third, the Japanese disasters are not happening in isolation. They add to the supply shock that the global economy already faces due to the uprisings in the Middle East and the related increase in oil prices. As such, the risk of a global macro tipping point cannot, and should not, be ignored.
Hawks gonna squawk, people. As with now, the Federal Reserve viewed the supply chain disruption in Japan as a temporary risk to inflation and economic activity in the United States. Accordingly the Fed did not view a change in monetary policy as an appropriate response. The following is from a special section in the staff forecast for the FOMC (now public) on “Economic Effects of the Earthquake in Japan,”
I remember several forecast meetings discussing the potential economic effects of the disaster. That’s when I learned that just-in-time supply chains have downsides. My colleagues knew that already. Fed forecasters are not infallible, but they are professionals. Too many of the talking heads now aren’t looking any further back than May 2021. That’s a mistake and leads to poor economic policy advice. Yes, it’s much more widespread this time with Covid, but such disruptions are not without precedent. And again, we have reaped years of benefits from global supply chains.
Finally, we should take today’s disruption as a warning. I heard early in the pandemic someone refer to Covid as our dress rehearsal for climate change. It ain’t looking good. Covid is a global crisis and its toll on human life is crushing. That said, we have a vaccine that works, and we will eventually contain the pandemic enough that we will work around the current economic log jams.
Climate change is a whole different ballgame. No company is going to engineer a cure over the weekend. Complain about the FDA now? Get ready for lots more complaining. Supply chain disruptions will not be the biggest problem we have during climate disasters, but Covid underscores some of the economic costs on the horizon. We are interconnected globally and as result, we are in this together. The answer now is to get vaccines to the world community as fast as possible. The United States should be leading with more great urgency. We are not. Climate change? Good luck with that.
Old Is New and New Will Get Old
Wrapping up, it’s crucial that we use today’s global supply chain disruptions and the problems that they are causing to talk about the big picture too. Global supply chains have kept prices for goods low for decades. But the risk of higher prices has existed too. We are exposed to problems at the sources of our production, most of which are no longer in the United States. Upward pressure on inflation now have occurred in the past, albeit at smaller scale. Finally, in terms of thereat to humanity and the economy, Covid is nothing compared to the looming climate-change crisis. Prepare now!
Happy Monday, y’all.
The St. Louis Fed summary includes Fed research, “The Contribution of Multinational Corporations to U.S. Productivity Growth, 1977-2000,” by my awesome former section chief, Paul Lengermann with Carol Corrado (super smart ex Fed!), and Larry Slifman. (legendary at the Board and also has a Rule.) Check out their paper!
Agreed that the Fed should be accommodating of supply side shocks and allow short term inflation to rise above its long term target. The complicating factor right now is that the idea of the Fed actually having an average inflation target and not an inflation ceiling is still pretty new, so that some folks are interpreting events as the Fed having adjusted upward is ceiling or even having abandoned the ceiling entirely in favor of a "hold nominal interest rates down to facilitate fiscal deficits" policy.
Supply shocks have the effect of making the Fed react in a wrong way. Hope this time the Fed is more careful! https://marcusnunes.substack.com/p/state-of-play-july-21