Inflation: supply or demand?

The debate among economists continues on whether the recent hike in inflation rates in the major economies is due to a ‘supply shock’ or ‘pent-up consumer demand’; and related to that, whether the inflation rise will be ‘transient’ or ‘permanent’.

Supply or demand?  If prices rise, is it because supply is not rising ‘enough’ or demand is rising ‘too much’?  That’s like the chicken and egg argument.  There is an answer to that conundrum.  After all, the chicken came first.  Chickens evolved from previous species; their eggs simply reproduce more chickens. 

Similarly, I would argue that prices and price changes are determined by changes in supply.  Or more precisely by the value of and changes in the value of commodities produced.  Value determines price at the highest level of abstraction.  Demand for commodities follows from the value produced and takes the form of money earned by workers (wages) and appropriated by capitalists (profits). 

In a capitalist economy, the price and value of an individual commodity can diverge.  Money is the representation of value but when money is not in the form of another commodity like gold, then non-commodity money can diverge from the value of the money commodity; and prices do not then match the value in commodities.  Prices in a modern monetary economy are determined by the supply of value embodied in their production and by the supply of non-commodity money.  So price inflation is supply-driven.  Demand for commodities is determined by the combined purchasing power of workers wages and capitalist profits – if you like, these are the eggs produced by the chicken of value production.  These eggs are necessary for the production of more value (more chickens), but they are still the result of previous chickens’ supply.

Where does this meandering on my part takes us?  In my view, it helps explain the causes of the current inflation rises.  The COVID pandemic slump was clearly a ‘supply shock’.  Production collapsed with lockdowns, workers were sent home or into hospital, transport and trade shuddered to a halt; social activity and events were replaced by isolation.  That then reduced demand, even though in the advanced capitalist economies, a major section of workers continued to get paid or got government handouts. 

So household savings rose significantly during the slump of 2020.

US household savings as % personal disposable income

This has led some to argue that these savings are ‘pent-up demand’ released in the year of vaccinations and economic recovery in 2021 and this created ‘excessive demand’ that caused the rise in the prices of goods and services – with inflation rates not seen for over 40 years. 

There is undoubtedly some truth in this explanation.  But the ‘pent-up demand’ was the result of the previous supply shock and price rises have accelerated only because ‘pent-up supply’ has not followed.  Also, much of the savings build-up was among the richer income groups, who could work from home and not spend much; unlike those in ‘essential’ services and transport and retail who are generally paid less and had to go to work.

Higher-income households and retirees are more likely to have increased their savings during Covid

So any increase in consumer spending is limited because those at the top of the income pyramid tend to save more than those at the bottom. Indeed, savings rates are back to ‘normal’ now.

IMF economists have just released a paper that aims to measure the relative contributions of supply and demand to rising inflation in 2021.  Globally, the economists reckon that “close to half of that upward swing (in inflation) came from the change in the supply shock component, which had mostly exerted downward pressure on manufactured-goods prices in the pre-pandemic years. The share attributable to supply shocks varies across individual countries; it is estimated at about half for the euro area, 60 percent for Germany and 45–50 percent in the United States and the United Kingdom, and about 40 percent for France and Italy”.   Note the impact of supply shocks in Mexico and Japan.

I would argue that this supply-side ‘shock’ is really a continuation of the slowdown in industrial output, international trade, business investment and real GDP growth that had already happened in 2019 before the pandemic broke.  That was happening because the profitability of capitalist investment in the major economies had dropped to near historic lows, and as readers of this blog know, it is profitability that ultimately drives investment and growth in capitalist economies.

If rising inflation is being driven by a weak supply-side rather than an excessively strong demand side, monetary policy won’t work.  Monetary policy supposedly works by trying to raise or lower ‘aggregate demand’, to use the Keynesian category. If spending is growing too fast for production to meet it and so generating inflation, higher interest rates supposedly dampen the willingness of companies and households to consume or invest by increasing the cost of borrowing.  But even if this theory were correct (and the evidence does not support it much), it does not apply when prices are rising because supply chains have broken, energy prices are increasing or there are labour shortages. As Andrew Bailey, governor of the Bank of England, said: “Monetary policy will not increase the supply of semiconductor chips, it will not increase the amount of wind (no, really), and nor will it produce more HGV drivers.” 

Nevertheless, the monetary authorities and mainstream Keynesian economists continue to emphasise ‘excessive demand’ as the main cause of inflation.  The hardline monetarists thus call for sharp rises in interest rates to curb demand while the Keynesians worry about wage-push inflation as rising wages ‘force’ companies to raise prices.  As FT columnist and Keynesian Martin Wolf puts it “What [central bankers] have to do is prevent a wage-price spiral, which would destabilise inflation expectations. Monetary policy must be tight enough to achieve this. In other words, it must create/preserve some slack in the labour market.” In other words, the task must be create unemployment to reduce the bargaining power of workers.  Full employment and wage increases are to be opposed.  Wolf and BoE governor Bailey claim this is to stop runaway inflation.  In reality, it is to preserve profitability. 

As I have shown in previous posts, there is no evidence that wage rises lead to higher inflation.  We are back to the chicken and the egg.  Rising inflation (chicken) forces workers to seek higher wages (egg). Indeed, over the last 20 years until the year of the COVID, US real weekly wages rose just 0.4% a year on average, less even that the average annual real GDP growth of around 2%+.  It’s the share of GDP growth going to profits that rose (as Marx argued way back in 1865).

Throughout the recovery period from the pandemic slump, it is prices that have outstripped wage rises.  As former White House economist, Jason Furman has shown, during the pandemic, US real wages (even after including benefits) have been falling and are now well below the pre-pandemic level.

Researchers at the Dallas Fed agree.  They found that “real wages have been falling over the last six months… even if they got (as indeed they did) real wage gains earlier in the expansion.”

There are two other indicators that rising inflation rates are really due to supply ‘bottlenecks’ and not ‘excessive demand.  First, industrial production (IP). In the US, the fastest recovering major economy, industrial output has jumped back in 2021 from the deep contraction of 2020.  But the IP index is still no higher than seven years ago and only marginally higher than just before the Great Recession in 2008.  The productive sectors of the US economy have been stagnating.

Then there is retail sales, supposedly a measure of consumer demand ,although retail sales cover only about 40% total consumer spending (leaving out spending on health, utilities and transport etc).  The latest monthly figure for US retail sales was heralded as showing a dramatic boom in consumer spending.  But when you account for inflation in food, energy and other retail goods, real spending was falling through 2021.

If rising inflation is really an indicator of weak supply and not strong demand, it means that monetary policy tightening (and the Fed is now planning sharp rises in its policy rate starting next month), will not curb inflation without pushing the US economy into stagnation or slump.  There is a danger that the US economy is heading for a ‘Volcker moment’, when the Fed chief of the later 1970s hiked interest rates into double-digits to crush high inflation. That triggered a stock market ‘correction’ and the deep post-war recession of 1980-2.  Just as now, profitability was at a post-war low, so the sharp rise in the cost of borrowing just led to a collapse in investment and eventually production.

Maybe the Fed will ‘chicken out’ of a Volcker move.  If so, with supply remaining weak relative to demand, we can expect inflation rates to stay higher for longer.

25 thoughts on “Inflation: supply or demand?

  1. “Maybe the Fed will ‘chicken out’ of a Volcker move. If so, with supply remaining weak relative to demand, we can expect inflation rates to stay higher for longer.”

    Surely, either way inflation would stay higher. The Volcker move prompted and was intended to prompt industrial capital to relocate to far cheaper sources of labour internationally to increase profits and production. This isn’t much of an option today?

  2. The argument presented in this post only makes sense if one considers capitalism=USA. That’s because the USA issues the universal fiat currency, the USD. In this scenario, one could argue for a “supply chains collapse” because, as the universal fiat currency, the USD should always be able to conserve its purchase power as it forces the rest of the world to give to the USA the correspondent goods for the money it prints.

    This argument could also have some weight in some other nations which have a fiat currency consistently stronger than the USD (the UK, the nations of the EZ). They indirectly benefit – even if only for some time – from the USD printing because they can import from the USA (directly or indirectly, by merely enjoying the new, even more favorable rates and thus buying even more from China). However, those nations cannot print money the way the USA does, therefore this windfall would be short lived.

    To claim otherwise, i.e. that supply is always the cause of inflationary waves, would be equivalent to ignoring the existence of the de facto enslaved working classes from Africa, Latin America, the Middle East and Southeast Asia. There’s a reason the term “bullshit job” was coined in the USA and not any other of the 200 or so nation-states in existence today.

    My diagnosis of this present-day inflation wave in the West (the USA specially) remains the same I’ve been touting in this blog’s comment section: it is due to a deficiency of value to exchange to China, not some supply/demand breakdown. The West simply doesn’t have the correspondent value to keep importing from China anymore, therefore even the USD Standard cannot sustain the USA’s low inflation rates (although it is, so far, just a crack, not a collapse). Since they cannot keep draining China, they are now having to resort to inflation in order to curb class struggle within their own confines.

    This means that I agree with Roberts and Carchedi’s Marxist conception of inflation: it is a tool of the capitalist class, in power of the Central Bank, to compensate for the pressure of higher wages as the development of the productive forces in capitalism advances, in the context where a fiat currency monetary system is in place and is hegemonic. It is, therefore, a counteracting factor for the tendency of the profit rate to fall.

    On a related subject, I recommend you all to read this article, published in The Nation on February 18th (still on the top of its homepage as of today), by James K. Galbraith:

    “How the Left Should Think About Inflation: There is no compelling reason to raise interest rates, now or later.”

    I recommend it because it is a monument for the decline of the USA, both because we can see the afflictions and dilemmas faced by the Capitalist Empire (USA), and because of the author’s own intellectual limitations (i.e. the intellectual decline of the USA, therefore of the West). Read slowly, word by word (no dynamic reading or just reading the last paragraph), because it is worth it. This is a historically important document which I even recommend saving it and printing it for posterity.

  3. Mister Roberts, I must inform you that your analysis of this mighty problem which is so concerning to all humanity, is totally wrong. I must set you and your readership straight on this subject.

    No, the chicken did not come first. You are correct that there had to be a first chicken. There was some sort of mutation which occurred in a non chicken which it passed on to its offspring to create the first chicken.

    The non chicken would have been an egg laying animal, like the chicken. So reproduction is mediated by an egg, which contains the organism until it hatches, hence the conundrum of which came first.

    Nothing altered the genes of the embryo in the egg between it being laid and the chicken being hatched. So the egg was a chicken egg from the start, even though it came from a non chicken. Thus, the first chicken egg happened before the first chicken.

    So there. Now, as for this minor problem of whether inflation is demand or supply driven, you get that right. Inflation is not caused by covid, but by the owner class deciding they aren’t getting enough money and picking up their marbles.

    My own minor blogging project is found at

    Subscribe and you can win your very own autographed portrait of a raccoon.

    Your welcome.

    1. “So the egg was a chicken egg from the start…”

      Thank God for that or how else could we count our chickens before they hatch?

      By the way, which came first – the placenta or the racoon?

      1. What a fascinating topic! I I have a lot of raccoon friends, so I decided to run this by Big Momma raccoon. She lives in the bushes behind the power station, raccoon HQ for this neighbourhood.

        She assures me that she has never laid an egg in her life. She is a placental mammal who gives birth to live young. Thus the question of the placenta or raccoon coming first is irrelevant.

        I am in Toronto, by the way; where we hatch too many racoons to count.

  4. Good article with good data. Let us hope the regulars here do not have another bar fight as happened in the previous post.

    This is the most important issue currently. Powell must be having continuous night sweats over interest rates. I agree with you that the supply side in the long run dictates prices changes. This can be seen with each and every new product. Take flat screen televisions. Originally a luxury good costing many thousands of $s or £s, but once the market for it was confirmed and mass production commenced, economies of scale reduced the price to hundreds of $s or £s despite better screens and features. The neo’s with their utility theory, that price is demand led, what consumers are willing to pay, what the brain tells the wallet, always get stumped by this phenomena, and it is just as true for other electronic gadgets, jet flight, motor cars and bamboo fiber underpants.

    Two issues. You are clearly not reading my website. If you had you will see that I only used the goods CPI. You cannot use the overall CPI, because as it includes services, it understates price rises for retail which is predominantly goods.

    Secondly, prices must deviate, not “can diverge” in a market economy for it to function. But this is not important, what is important is general price levels. Now here is the thing. Please view the Implicit Price Deflator going back to Bretton Woods and beyond. Just google: FRED Table A191RI1A225NBEA. Lo and behold, the period of greatest price stability has been the last thirty years, not during the gold standard. How is it possible that paper money, call it state currency not fiat money, has achieved this. They must be using some special paper to print those dollars you could say. Nothing to do with this. What state currency does, as I have said countless times, is that it exchanges legacy value for current value, both sides being equally real. As long as legacy value, in the form of previous unspent revenues represents more than 90% of M2 it forms the ballast keeping prices stable. It is also why, immaterial money in the form of digital money would work just as well as paper money, but be less polluting to produce. This is the essence of Modern Marxist Monetary Theory, the understanding of how money takes legacy value in one hand and current value in the other, before swopping hands.

    1. ”The neos with their theory of utility, that the price depends on the demand, what consumers are willing to pay, what the brain tells the wallet,”
      Certain. One way to refute the theory of utility, and any other economic theory with ultimate cause based on demand, is from advanced neuroscience, which refutes the previous “braincentrism”: the brain tells NOTHING to the wallet. Brains don’t know anything about wallets, they don’t know anything about economics, they don’t have any knowledge or belief. Because they don’t know they don’t know they exist. All knowledge is outside the brain and it is only limited to capturing, filing, processing and intermediate information under the direct order of each individual. And it is the individuals, and their different knowledge derived, mainly, from their different work occupations, who know, or not, about economics and know, or not, about everything else. And they are the ones who give you the orders, different orders according to each individual, place and time, to your wallet. The correct casual relationship direction is environment (culture) to brain and not the other way around. What neuroscience has discovered is what Marx said about society being created by individual consciousness and not the other way around. Current neuroscience confirms Marx, and confirms Materialism. Therefore, the demand in a market is created by the offer (environment-culture). And, therefore, production and its benefit come before consumption. And finally, and therefore, inflation is basically a product of supply.

      1. ”what Marx said about society being created by individual consciousness”
        This is a Google translation error (common errors, by the way). Marx obviously said the opposite: it is society that creates individual consciousness.

    2. UCBP

      ” How is it possible that paper money, call it state currency not fiat money, has achieved this.”

      Nothing to do with money per se, I would argue.

      I would say globalization and the mal-distribution of income in the West accounts for the benign inflation performance of the last 30 years.

      1. Well spotted that I was being abstract. Of course concretely inflation is the barometer of the class struggle which has been absent while globalisation and the cheapening of articles of consumption has been present.

      1. When current value is monetised by means of a sale, the seller is in receipt of sales revenue. This revenue is generally banked where it adds to M2. Once value is monetised in this way it becomes legacy value because it belongs to a previous period of production and circulation and not to the current one. Hence the category legacy, as belonging to the past. Hope this answers your question. There are a number of articles on MMMT on website

  5. “I would argue that this supply-side ‘shock’ is really a continuation of the slowdown in industrial output, international trade, business investment and real GDP growth that had already happened in 2019 before the pandemic broke. That was happening because the profitability of capitalist investment in the major economies had dropped to near historic lows, and as readers of this blog know, it is profitability that ultimately drives investment and growth in capitalist economies.”

    Exactly right…

    and since it appears acceptable to self-advertise on Michael’s site, I, ever so humble hesitantly but wholeheartedly endorse myself: and
    and… etc etc etc

  6. “That’s like the chicken and egg argument. There is an answer to that conundrum. After all, the chicken came first. Chickens evolved from previous species; their eggs simply reproduce more chickens.” -> The FIRST chicken hatched from an … egg. Laid by an animal that WAS NOT a chicken. Crocodiles and dinosaurs have been laying eggs hundreds of million of years before chickens.

    1. I have to assume you have not read my brilliant solution to the chicken and egg conundrum. A chicken can only hatch from a chicken egg. If a chicken comes from it, it is a chicken egg, even if it came from a non chicken. It would be very interesting if a chicken laid a dinosaur egg.

  7. Higher wages mean a lower rate of profit. One way to mystify the process of lowering wages is to devalue the currency. The pandemic has provided the perfect opportunity to finally let some of the air out of the QE inflated currencies’ value in the marketplace of commodities.

  8. Chickens are social. They interact in numerous ways. You are quite right the certis parabus profit expectation drives supply but go ernments sit above marked and can effect things in other ways. There is an iron law that without an equal increase in value of products printing money is inflationary. It’s chickens eggs and a gov that can eat both. Add to Marx althusairs overdetermination. It’s dialectical consumers producers and governments. And anyone can be thesis depending on where you want to intervene

  9. Great article and discussion where we agree supply or production and its profit base as the driving problem. As marxists we can analyse but if the point is to change it, the question is how do workers respond to the rising cost of living and how in particular they articulate and fight for higher wages, particularly when labour power itself is in short supply and worker militancy may be rising, particularly in the US. Given the debate on short or longer term changes for the price of goods and services, what is the story with the supply, and price of, labour power in the current period?
    Thanks for any leads for info or opinion.

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