Inflation Mainly Driven by Supply

Apollo Chief Economist

US and European inflation for the past two years has been almost identical despite the fiscal response to covid being double the size in the US relative to Europe, see charts below.

With a much more aggressive fiscal response in the US, both headline and core inflation should have been much higher in the US today than in Europe.

The identical path of inflation in the US and Europe strongly suggests that inflation is not driven by demand but instead by supply problems associated with covid. Some of these supply problems for goods will get resolved quickly as supply chain problems ease. But other supply problems in the labor market will take some longer time.

The implication for markets is that the Fed and the ECB may not need to do much demand destruction to get inflation down.

This topic is also debated in several Fed working papers at the moment, see here and here.

Chart showing inflation in the US and EU has mostly followed the same path
Source: Bloomberg, Apollo Chief Economist
Chart showing that the fiscal response to COVID in the US has been much greater than the EU in 2020 and 2021
Source: OMB, ECB, Haver Analytics, Apollo Chief Economist

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