Is Inflation High Because of Demand or Supply?

Apollo Chief Economist

There is an ongoing debate about whether the current high levels of inflation are the result of aggressive monetary and fiscal policy or supply chain problems and lower labor supply.

A straightforward way to analyze this question is to look at what happened to aggregate demand and aggregate supply during covid.

Demand: The size of the fiscal and monetary policy response to covid at $10trn was very significant, or about 40% of 2022 GDP, see the first chart. The magnitude of these numbers suggests that demand is playing a key role as a driver of inflation.

Supply: The CBO estimates that the covid shock, combined with the fiscal and monetary response, has increased the overall capacity of the US economy, see the second chart which shows that the CBO’s current estimate of potential GDP in 2023 is higher than the estimate for potential GDP in 2023 they had in 2019. In other words, the covid shock did not lower the capacity of the US economy.

The bottom line is that while supply chain problems initially boosted inflation, the current high level of inflation is the result of easy money and fiscal policy, not because of a decline in the capacity of the US economy.

Source: FRB, BEA, Haver Analytics, Apollo Chief Economist
Source: CBO, Haver Analytics, Apollo Chief Economist

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