The more targeted regulatory and fiscal measures succeed in easing supply bottlenecks, the less likely it is that policymakers will be forced to rein in aggregate demand and economic growth to contain inflation.
When countries told people to stay home to control Covid-19, consumers cut back on spending on services and instead bought more manufactured goods.
The reopening of economies has boosted manufacturing output, but further shutdowns and shortages of intermediate inputs, from chemicals to microchips, have stalled factory recovery. Prices for consumer staples rose rapidly as delivery times hit record highs, sparking a debate over inflation and the course of monetary policy.
We estimate that eurozone manufacturing output in autumn 2021 would have been around 6% higher without supply constraints. Based on the historical correlation between manufacturing and overall output, we estimate that gross domestic product would have been around 2% higher, equivalent to around a year of growth in normal times before the pandemic for many European economies.
The drag on production has been greatest in countries where manufacturing firms operate downstream of global value chains and depend on highly differentiated intermediate inputs. Prime examples include countries with large automotive sectors, such as Germany and the Czech Republic, where manufacturing output would have been up to 14% higher.
Supply constraints also played an important role in producer price inflation in the Eurozone, but so did the strength of demand. The manufacturing component of producer price inflation was about 10 percentage points higher relative to the pre-pandemic period in the first three quarters of 2021. We estimate that supply shocks can explain about half of the increase in manufactured goods price inflation. The rest is mainly explained by the increase in demand.
Supply disruptions had less impact on underlying consumer prices (inflation excluding energy and food prices). This measure of inflation was only about 0.5 percentage point higher over the same period due to manufacturing supply constraints than it otherwise would have been. This smaller effect is not surprising since goods represent less than half of the consumption basket. The prices of services, which account for more than half, are less sensitive than those of goods to manufacturing supply shocks.
Problems may persist
Globally, we find that up to 40% of manufacturing supply constraints can be attributed to shutdowns, which are expected to have only transitory effects on inflation. The same goes for inclement weather and industrial accidents that hampered microchip and automobile production in 2021. Other supply constraining factors, such as labor shortages (which account for up to 10% of global manufacturing supply constraints) and aging logistics infrastructure, however, may have more persistent effects on supply and inflation than shutdowns.
Late last year, industry experts expected auto supply shortages to largely dissipate by mid-2022, and wider bottlenecks by the end of this year. Omicron injected new uncertainty. Europe and China have imposed new restrictions and further disruption may follow. Overall, supply disruptions could last longer, possibly until 2023.
The first line of defense is to directly address supply bottlenecks with regulatory measures where possible, such as accelerating the licensing of transport and logistics workers, easing temporarily restrictions on port opening hours, streamlining customs inspections, easing immigration rules to ease labor shortages. , and impose practices that limit the spread of the virus and protect the health of workers.
Fiscal measures should also be actively deployed to ease bottlenecks and avoid lasting damage to potential output. Widespread support for aggregate demand at present could intensify bottlenecks and increase inflation with limited impact on output and employment. Instead, support should be well targeted.
For example, it remains important to preserve jobs that will be viable once bottlenecks ease (such as skill-intensive manufacturing jobs affected by shortages of intermediate inputs). It is equally vital to ensure a recovery in labor supply by removing barriers to work (by developing reliable care for children and the elderly, for example) and helping to train workers. new skills needed.
The prospect of prolonged supply bottlenecks poses challenges for monetary policymakers – namely, to sustain a still incomplete recovery and ensure that output catches up to its pre-pandemic trend – without letting wages and prices skyrocket. Keeping medium-term inflation expectations stable despite transitory spikes in inflation, notably due to supply disruptions and soaring energy prices, is key to managing this trade-off.
Despite the rapid tightening of labor markets in the eurozone, recent data and historical precedents suggest that wages will only rise moderately, and so we expect inflation to fall slightly below the target for the European Central Bank once the pandemic has passed. The ECB has rightly decided to maintain an accommodative monetary policy until its medium-term inflation target is met, while preserving its flexibility to adjust its path if high underlying inflation proves more sustainable. provided that.
In general, to anchor inflation expectations at target rates, it is essential that central bankers continue to communicate how they will react to inflation and other economic data, including movements in inflation expectations, and signal that they are ready to react quickly to any significant change in the environment. long-term inflation outlook.
The more targeted regulatory and fiscal measures succeed in easing supply bottlenecks, the less likely it is that policymakers will be forced to rein in aggregate demand and economic growth to contain inflation. — IMFBlog