Broker Check

How Much Can Global Supply Chain Pressure Ease?

| February 22, 2023

Inflationary pressures—their determinants and evolution—continue to dominate policy discussions. In this post, we provide a simple framework to analyze the determinants of different measures of inflation and use it to lay out a risk-scenario analysis. We find that global supply factors captured by the New York Fed’s Global Supply Chain Pressure Index (GSCPI) are strongly associated with inflationary developments measured by the producer price index (PPI) and by the c0nsumer price index (CPI). Under the assumption that the GSCPI falls back to its historical average over twelve months, our model would project a substantial easing of consumer price inflation over 2023 to below 4.0 percent. The normalization of the GSCPI would then be consistent with a return of inflation to levels consistent with a soft-landing scenario.

U.S. Inflation and Its Determinants

We formally quantify the contemporaneous correlations between different measures of inflation for the United States and global supply and demand factors using monthly data from 1998 to 2022. As in our earlier blog post (“The Global Supply Side of Inflationary Pressures”), we run linear regressions that relate the different measures of year-on-year inflation rates with our GSCPI measure, a measure of potential demand factors (see our companion blog post for the computation of demand factors), year-on-year changes in the broad nominal trade-weighted U.S. dollar index, as well as our estimate of the global oil supply factor behind year-on-year oil price changes. This approach yields the average monthly correlations between the inflation measures and our demand and supply factors for a sample of data going back to 1998.

Although we do not report the estimated coefficients here, three key results are worth highlighting from our analyses. First, both global supply and global demand factors are associated with intermediate demand goods PPI inflation, consistent with the globally traded nature of the goods in this index. Second, the U.S.-specific demand factor becomes relevant in contributing to CPI inflation on top of supply components captured by the GSCPI. Third, as could be expected, the GSCPI is more associated with goods CPI inflation than with overall inflation.

We next use the estimated regression relationships to explore how these supply and demand factors have correlated with recent inflation developments. We do so by first re-running the regressions using data through June 2021. We then use the regression estimates along with the observed values of the GSCPI, demand factors, exchange rate changes, and global oil supply factors from June 2021 to January 2022 to calculate projected inflation rates from the model.  

The upper panel of the chart below shows the results for PPI inflation. The regression models do a quite good job at tracking PPI inflation, while the bottom panel of the chart illustrates that the models can track the changes in overall CPI inflation, though, in that case the levels of inflation are much higher than our model predicts. This is consistent with the notion that PPI is relatively more influenced by global factors compared to broader measures of consumer prices that include larger weights on non-tradable services.