In the continuing quest to write about all the interesting stuff that has been overshadowed by the FTX shit vortex for the past few weeks, it’s time to turn to a fascinating article on “systemically significant” inflation.
In other words, not all price increases are equal. Some are much more influential on overall inflation rates than their weightings would imply, due to their role as inputs into whole swaths of the wider economy.
It makes intuitive sense. But perhaps more importantly, many of these systemically important prices are actually difficult, if not impossible, to influence through monetary policy, and require finer-grained micro-policy responses to bring them under control.
Here is the summary of the article written by Isabella Weber, Jesús Lara Jauregui, Lucas Texeira and Luiza Nassif Pires:
In the overlapping global emergencies of the pandemic, climate change and geopolitical confrontations, supply shocks have become frequent and inflation has returned. This raises the question of how sectoral shocks relate to overall price stability. This article simulates price shocks in an input-output model to identify sectors that present systemic vulnerabilities to monetary stability in the United States. We call these prices systemically significant.
We find that in our simulations, the pre-pandemic average price volatilities and price shocks in COVID-19 and wartime inflation in Ukraine produce an almost identical set of systemically significant prices. Sectors with systemically significant prices fall into three groups: energy, basic production inputs other than energy, basic necessities, and trade and financial infrastructure. Specifically, these are “Petroleum and Coal Products”, “Oil and Gas Extraction”, “Utilities”, “Chemicals”, “Farms”, “Food and beverages and tobacco products”, “Housing” and “Wholesale trade”.
We argue that in times of overlapping emergencies, economic stabilization must go beyond monetary policy and requires institutions and policies that can target these systemically important sectors.
This goes against the common economic dogma that inflation is a purely macroeconomic problem, which monetary policy is the best – perhaps the only – tool to tackle.
As Milton Friedman’s tiresome quote puts it, “Inflation is always and everywhere a monetary phenomenon.” And as the paper points out, even New Keynesians see it as a product of aggregate demand and capacity utilization. But wars, droughts and trade disputes are hard things for central banks to solve.
Economists simulated shocks in each of the 71 industries in the U.S. Bureau of Economic Analysis’ input-output table, using price changes between 2000 and 2019 to identify “systemically significant” drivers of headline inflation. Here is what they found:
As expected, the food and energy industries are the main direct and indirect drivers of inflation. So even if you use a “basic” CPI measure that removes them, their impact will still be significant. And one wonders to what extent monetary policy can actually affect demand for them.
The implications for today are quite obvious. If monetary policy has limited impact on these systemically important drivers of inflation, should central banks really overcompensate, raise rates aggressively and destroy demand to drive down all other prices, regardless of or the economic cost?
Isabella Weber, professor of economics at the University of Massachusetts and lead author of the paper, has a good thread summarizing their findings here, but we recommend people check out the full article.
Inflation might ease for the time being, but we live in a time of overlapping emergencies. Other shocks are likely to occur. We need economic policy preparation for micro-stabilization. But what prices matter?
A new working document 🧵https://t.co/Oep2U2OhVc pic.twitter.com/ROqr8qtEEv
—Isabella M. Weber (@IsabellaMWeber) December 3, 2022
