As is so often the case in macroeconomics, the title of this post isn’t even a question. Terms like ‘supply’ and ‘demand’ are not clearly enough defined to make this a meaningful question. Whatever answer you provide is defensible, depending on how one defines terms.
Let’s consider a few plausible possibilities.
1. Total aggregate demand (NGDP) has been rising at a rate of just under 4% over the past 7 quarters. This is close to trend. Thus there has been no unusual demand shock by this metric.
2. But the Fed doesn’t target NGDP; it targets inflation. Inflation has somewhat exceeded the Fed’s 2% target over the past few years. Thus policy was too expansionary by this metric. Therefore the problem is excessively expansionary monetary policy, i.e., too much demand.
3. But the Fed doesn’t just target inflation; it has a dual mandate that includes employment. Employment is still somewhat depressed. Indeed NGDP is one plausible way of think about the dual mandate, as it includes both inflation and real growth. And as we saw in point #1, by that metric demand is right on target.
The question of whether there is too much supply or too much demand depends in part on what sort of benchmark you use. What is a “normal” or “appropriate” increase in aggregate demand? Opinions will differ.
Even worse, the terms ‘supply’ and ‘demand’ have ambiguous meanings that differ between macroeconomics and microeconomics. And even worse, many people (most?) don’t understand this distinction.
Ramesh Ponnuru has a tweet linking to an article that argues the inflation is due to supply issues. Someone responded to his tweet as follows:
This tweet raises an interesting point; how do we think about sectoral demand shifts that look like supply shocks at the aggregate level?
Readers of this blog know that I frequently point out that the AS/AD model has almost nothing to do with supply and demand as we use the terms in microeconomics. Thus consider a sudden drop in demand for services due to Covid. If the Fed does enough stimulus to keep total demand rising at 4%/year, then by necessity the demand for goods will soar well above trend to offset the decline in services.
The problem here is that it’s difficult to suddenly turn unemployed hotel workers into truck drivers delivering goods. Even harder to suddenly build more port capacity. At a macro level, the excess demand for physical goods looks like a negative supply shock, and indeed in a sense it is a negative shock to aggregate supply. For a given level of nominal spending, our economy is not capable of producing as much real output (goods and services) as before, at least relative to trend. Reallocation is difficult. That’s a negative aggregate supply shock at the macro level, and an excess demand for goods shock at the sectoral level.
In the end, the debate about whether this is “actually” a supply or demand shock is completely sterile. The terms are not well enough defined to offer a definitive answer. It’s not an interesting question. What is an interesting question is whether monetary policy is appropriate, too expansionary or too contractionary. I suppose that those who view the current problem as “supply” are mostly content with the recent monetary stimulus. Those who regard the inflation as due to “demand” mostly think Fed policy has been too expansionary. If so, then they should say that directly.
PS. Nick Rowe once said:
Some people argue about whether the macroeconomy is inherently stable or unstable. I don’t think that’s a very useful question. Because…..it depends. And one of the things it depends on is monetary policy. And that is a useful discussion to have, because we can actually do something about monetary policy.
After I wrote the final paragraph of this post I was reminded of this Nick Rowe comment, and looked it up. Now I feel that I almost plagiarized Nick. Sometimes other people influence our thinking without us even realizing it.
READER COMMENTS
MarkLouis
Nov 2 2021 at 4:24pm
I would say most of the economists who comment on inflation in the public press get this wrong. They act as though the Fed is powerless to stop inflation in the face of supply constraints. The Fed is perfectly able to do so – if demand were matched to supply some things would fall in price to offset the rising prices in supply constrained areas.
The Fed is only powerless to cap inflation if it willingly chooses instead to target employment, income, or some other non-inflation variable. It may be the right choice, but it’s a choice nonetheless.
Scott Sumner
Nov 2 2021 at 5:06pm
That’s right.
John Hall
Nov 2 2021 at 5:30pm
Alternate title: “Inflation: Is it Nominal or Real”?
Jose Pablo
Nov 2 2021 at 5:58pm
To use another approach, people running a business think about this in a different and pretty straightforward way:
When they try to hire people and could not find any, try to buy supplies and can’t find them where they used to … there is a supply problem.
When they hire as they want, and supply chains run at their satisfaction, but clients don’t show up there is a demand problem.
For them it is clear where we are.
In an ideal world models should be used to “explain” what agents do (and “feel”) not to teach them what they “should” feel.
Coase approach to economics:
https://reason.com/1997/01/01/looking-for-results/
Coase: […] Economics has been becoming more and more abstract, less and less related to what goes on in the real world. In fact, economists have devoted themselves to studying imaginary systems, and they don’t distinguish between the imaginary system and the real world. That’s what modern economics has been and continues to be. […]
Scott Sumner
Nov 2 2021 at 11:09pm
Sorry, that’s not what economists mean by “supply” and “demand”. When resources are unavailable we call that a “shortage”. Supply is a different concept, it’s the amount offered at various prices.
David Seltzer
Nov 3 2021 at 4:17pm
Scott: When resources are unavailable we call that a “shortage”. As I understand shortage, it’s because of government intervention. If the first law of economics is scarcity, then supply scarcity is reflected in market pricing. Am I missing something here?
Scott Sumner
Nov 4 2021 at 12:45pm
Yes, shortages are usually due to government policies. Scarcity is a different concept, unrelated to shortages. Yes, scarcity impacts market prices.
rsm
Nov 2 2021 at 11:05pm
《When they try to hire people and could not find any, try to buy supplies and can’t find them where they used to》
How do you know they’re not just selling you a narrative? Are they trying to hoard because, everybody’s doing it? The toilet-paper shortage was man-made, right? Was it resolved when irrational psychological expectations settled down? Supply remained fairly constant, but did irrational panic lead to an illusionary supply problem?
Anyway, why can’t the Fed treat inflation as a payment systems problem, and supply money to individuals so business demand for money can be satisfied?
Everett
Nov 3 2021 at 1:09am
From what I’ve read the toilet paper shortage was both a supply and man-made hoarding issue.
Supply because the manufacturers had to shift their production lines from business-type toilet papers to home-use toilet papers when the COVID shutdown kicked in, which was not an insignificant task.
Travis Allison
Nov 3 2021 at 1:05pm
Scott, what definitions do you find useful for “supply” and “demand” at both the macroeconomic level and microeconomic level?
Scott Sumner
Nov 4 2021 at 12:47pm
You should use different definitions in those two cases, they are unrelated concepts. For AD, I use NGDP. For demand, it’s quantity offered at a given real price.
Travis Allison
Nov 5 2021 at 1:10pm
How would you define macroeconomic “supply”? “All goods and services offered for sale in the economy”?
Spencer Bradley Hall
Nov 4 2021 at 12:59pm
re: “Even harder to suddenly build more port capacity”
Read “I’ve Been Driving Trucks For 20 Years, I’ll Tell You Why America’s “Shipping Crisis” Will Not End”
I’ve Been Driving Trucks For 20 Years, I’ll Tell You Why America’s “Shipping Crisis” Will Not End – CLOUDHEDGES
Impose the Taft-Hartley Act. Bust the Unions.
“California has imposed a “green” law against truckers whose trucks are older than 11 years, which is most independent owner-operators. California wants to replace “dirty diesel” trucks with “clean electric trucks” – that don’t exist. Meanwhile dozens of ships are anchored off the Port of Los Angeles unable to provide their abundant supply of goods to the people who want to buy it because there is a shortage of “clean new” trucks to haul the containers around the country.”
“You missed a big point on the Truck driver supply chain port issue. Many truck drivers are owner/operators who work for themselves. Also many small non union trucking companies. The Long shoremen at the port of LA have for years gotten away with refusing to load non union trucks or those with non Union drivers. Governor Stupid of California signed into law last Month (Sept2021) that non union drivers can’t pick up loads in the Port of LA. So during the slow down many truck drivers changed profession so there just aren’t enough. Biden bragged how his Admin approved had the transportation department approve 600,000 truck drivers licenses in 2020. I was waiting for the press to point out he wasn’t in office. I’m still waiting!”
Spencer Bradley Hall
Nov 4 2021 at 1:03pm
The National Association of Home Builders Discusses Economics and Housing Policy”Number of Builders Declined 50% Between 2007 and 2012″
US Government: Number of Builders Declined 50% Between 2007 and 2012 | Eye On Housing
The government bailed out the banksters, but not the homebuilders.
Link: Once-In-A-Generation Response Needed to Address Housing Supply Crisis”WASHINGTON (JUNE 16, 2021) – Decades of underinvestment and underbuilding have created a shortage of housing in America that is more dire than previously expected and will require a concerted, long-term nationwide commitment to overcome”
Once-In-A-Generation Response Needed to Address Housing Supply Crisis (nar.realtor)
For 14 years beginning in 1993 the average number of new single family homes averaged 110 (in thousands of units, FRED database) ending in July 2007. Then there were never over 100 (in thousands of units) of new single family dwellings built in any month between August 2007 and September 2021.The average number of new single family homes then averaged 57 (in thousands of units), for the 13 years between Sept. 2007 and Sept. 2021. That’s a huge shortfall.
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