Supply/Demand Shocks, Global Supply Chains and Inflation

Since early 2020 we observed large swings in economic activity characterized by collapse and rebound in domestic demand, GDP, and international trade; consumption substitution across sectors; and heterogeneous labor shortages across sectors and countries due to pandemic, lockdowns and recovery. We explore how much of the observed inflation patterns in the Euro Area and the US are due to supply and demand shocks via an open-economy model incorporating inter-country inter-industry input-output linkages. We find that compositional effects – the switch from services to goods consumption – are amplified through global input-output linkages, affecting both trade and inflation. Inflation can be higher under sector-specific labor shortages relative to a scenario with no such supply shocks. Foreign shocks and global supply chain bottlenecks played an outsized role relative to domestic aggregate demand shocks in explaining Euro Area inflation