For release on delivery
11:15 a.m. EST (10:15 a.m. CST)
January 6, 2023
Thoughts on Inflation in a Supply-Constrained Economy
Remarks by
Lisa D. Cook
Member
Board of Governors of the Federal Reserve System
at the
2023 Allied Social Science Associations (ASSA) Annual Meeting
New Orleans, Louisiana
January 6, 2023
I am particularly pleased to be here today for multiple reasons. I think most of us
feel some nostalgic pull to these meetings, though I do not think I want to revisit the
frantic interview cycle ever again. These meetings allow us to meet and reconnect with
colleagues, hear about new and valuable research, and have in-depth discussions on the
subtler, more nuanced aspects of economics. I hope to do that today with my co-panelists
on a subject that has my and the Federal Open Market Committee's full attention:
inflation. I want to use my time to outline the unique set of challenges facing
policymakers and academics today as well as how we can better understand inflation
dynamics in this new environment, including by looking at novel data sources.1
The effects of the pandemic and Russia's war against Ukraine have turned a
spotlight on the supply side of the economy and its ability to adapt to rapid changes in
demand and to navigate a seemingly never-ending sequence of adverse supply shocks.
The unique nature of the supply and demand imbalances over the past couple of years has
made it more difficult to forecast inflation, posing new challenges for monetary policy.
One way to better manage these challenges is by continuing to monitor-and even
expand-new sources of data. Additionally, we have some key issues to consider in
approaching revised models of inflation behavior.
Before I turn to broader issues with modeling inflation, let me start with the recent
inflation data. Inflation remains far too high, despite some encouraging signs lately, and
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is therefore of great concern. As a Fed policymaker, I am committed to bringing inflation
back to our 2 percent goal.
The 12-month change in total personal consumption expenditures (PCE) prices
through November was 5.5 percent. Core PCE prices rose 4.7 percent over the same 12-
month period (figure 1). This measure omits volatile food and energy prices and tends to
give a more accurate signal of total inflation's trajectory. Both figures are down a bit
from the peaks reached in the first half of last year. However, monthly data are quite
volatile, so I would caution against putting too much weight on the past few favorable
monthly data reports.
The high and volatile inflation seen over the past two years appears to reflect
rapid shifts in demand, coupled with supply-chain disruptions. This has led to sizable
demand-supply imbalances across different sectors. To analyze these influences, I find it
useful to consider core inflation in three categories corresponding to distinct components
of consumer spending: core goods inflation, housing services inflation, and inflation in
core services other than housing (figure 2). In contrast to core goods inflation, which has
declined over the past year, housing services inflation has continued to rise rapidly, and
inflation in other core services has been little changed on balance. In the current
environment, I find it helpful to examine a number of somewhat new indicators when
assessing inflation pressures within each category.
Starting with goods inflation, I have been closely observing indicators of capacity
constraints along global and domestic supply chains. Shortages, bottlenecks, and other
logistical issues have hampered production and boosted distribution costs for a
significantly longer period than we had anticipated a couple of years ago. Fortunately,
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many indicators suggest that shortages of inputs have abated, and transportation costs
have started to fall. For example, the list of industrial inputs that respondents to the
Institute for Supply Management's (ISM) manufacturing survey indicate are in short
supply is now shorter than it was at its peak at the end of 2021 (figure 3). Supply
constraints are far from fully resolved, however, and respondents to the December ISM
survey still reported difficulty procuring items such as electrical and hydraulic
components, rubber and steel products, and-of course-semiconductors. The supply of
semiconductors has been a particularly strong driver of inflation in the motor vehicle
sector and has affected that sector's ability to produce vehicles-a matter I highlighted in
a speech in Detroit in late November.2
In assessing the degree to which shortages of materials and other inputs are
constraining goods production, I have been following the Quarterly Survey of Plant
Capacity Utilization, which asks firms whether production in their plants was below full
capacity in a particular quarter and the reasons for any shortfalls (figure 4). These data
show a decline over the past year in the number of plants that continue to operate below
full capacity due to logistical challenges as well as parts or labor shortages.3 Yet those
readings remained quite elevated in the third quarter of last year relative to rates observed
before the pandemic.
2
See Lisa D. Cook (2022), "The Economic Outlook and U.S. Productivity," speech delivered at the Detroit
Economic Club, Detroit, Michigan, November 30,
https://www.federalreserve.gov/newsevents/speech/cook20221130a.htm.
3
For information on the checkbox data from the Quarterly Survey of Plant Capacity Utilization, see Jessica
Stahl and Norman Morin (2013), "Looking for Shortages of Skilled Labor in the Manufacturing Sector,"
FEDS Notes (Washington: Board of Governors of the Federal Reserve System, September 26),
https://www.federalreserve.gov/econresdata/notes/feds-notes/2013/looking-for-shortages-of-skilled-laborin-the-manufacturing-sector-20130926.html; and Justin Pierce and Emily Wisniewski (2018), "Some
Characteristics of the Decline in Manufacturing Capacity Utilization," FEDS Notes (Washington: Board of
Governors of the Federal Reserve System, March 1),
https://www.federalreserve.gov/econres/notes/fedsnotes/some-characteristics-of-the-decline-in-manufacturing-capacity-utilization-20180301.html.
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Turning to housing, a sector in which demand has been quite strong since the
onset of the pandemic, the housing services component of core PCE has continued to
register rapid increases. However, the housing services index tends to adjust quite
slowly, as it measures the rise in rents for all tenants, including those with continuing
leases, and the rise in the rental-equivalent cost of owner-occupied housing. Changes in
the rental market are reflected in measures of average rents with a lag. Partly for this
reason, I find it useful to consult market rents paid for new leases, which are a more
timely indicator of how housing services prices are likely to change over the next 6 to 12
months (figure 5). Available measures of market rents suggest that the price increases for
new tenant leases have slowed substantially over the past year. Some monthly measures
have barely increased or even declined recently. This pattern may in part reflect the
easing of some special factors that shifted demand during the peak of the pandemic, such
as the surge in work from home and the associated increase in demand for bigger homes
located in smaller metro areas or further from city centers. Because these shifts in
demand happened much more rapidly than the response in housing supply, rents
increased quite significantly, especially for single-family detached homes. Some of this
shift in demand may have stabilized over the past year as the pandemic has waned,
amenities and cultural activities in urban areas have re-opened, and more workers have
returned to the office (figure 6). Although PCE housing services prices will likely
increase further in the coming months as renters renew their leases, the deceleration in
market rents suggests this process should slow appreciably over the course of this year.
Lastly, inflation in other core services-a large category that covers activities as
varied as travel and recreation to medical and legal services-has remained stubbornly
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high. As my colleagues and I have noted in the past, an important source of inflation
pressures in this category is the shortage of workers, which has pushed up labor costs at
rates above those consistent with 2 percent inflation. The inflation outlook for this non-
housing category of core services partly depends on whether growth in nominal labor
costs comes back down, and recent data suggest that labor-compensation growth has
indeed started to decelerate somewhat over the past year. In addition to keeping close
tabs on measures of labor costs, I have found it valuable to use some high-frequency
indicators of services spending, particularly in the leisure & hospitality and travel sectors
(figure 7). Even as the effects of the pandemic overall appear to be subsiding, the ebbs
and flows in the spread of the COVID-19 virus (in addition to other respiratory viruses)
continue to add significant volatility to monthly inflation readings in these sectors.
Crucially, we must be vigilant to ensure that pandemic-era cost pressures and
disruptions do not have lasting effects on inflation. If cost shocks and supply disruptions
keep inflation elevated for a long enough period, households' and firms' inflation
expectations could move higher-a development that could put additional upward
pressure on inflation.
Accordingly, I look at a variety of measures of inflation expectations-near- and
long-term, as well as survey- and market-based-that cover many different participants in
the economy. Since the onset of the pandemic, medians of many surveys of longer-run
measures suggest that inflation expectations are still within their pre-pandemic ranges,
despite having come up a little. This is consistent with overall PCE price increases
declining to a 2 percent pace. Market-based measures of inflation compensation beyond
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the near term, such as those derived from Treasury Inflation-Protected Securities, or
TIPS, tell a similar story.
I have also looked beyond the headlines of the survey data to assess how inflation
expectations are moving and responding to the current high-inflation environment. For
example, in the Michigan Surveys of Consumers, we can compare households'
perceptions of past inflation to their expectations of future inflation at the 1-year and 5-
to-10-year horizons (figure 8). The comparisons show that while households have raised
their inflation expectations over the past few years, especially for the short-term measure,
the increases were far less than one-for-one with how much they perceived inflation had
already risen. I will monitor these comparisons to ensure that inflation expectations
remain well anchored. Any de-anchoring of expectations would be a major concern, as it
could cause the high inflation that we have been experiencing to prove more persistent.
Looking ahead, the outlook for inflation will depend, in part, on how the factors
restraining supply responses and boosting cost pressures in each of these three main PCE
price categories play out. I think it is quite possible that the organization of production
and supply chains will look different in the coming years from the way they did before
the pandemic, as firms evaluate some newly exposed tradeoffs between keeping costs
low and supplies available. We should keep a close eye on the incoming indicators of
production disruptions and bottlenecks. We should also advance our understanding of
how an environment of more frequent disruptions to the production and distribution
systems will affect potential output, feed into inflation, and become an important element
in forecasting inflation, assessing risks, and adjusting monetary policy.
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We must also continue to advance our understanding of inflation and its
underlying structural causal relationships as well as our ability to forecast risks. Progress
in these areas would help us better assess developments in real time.
Some questions deserve further attention and study. As sectoral supply-demand
imbalances have played a key role in understanding inflation in recent years, would
adopting a model with multiple price components improve our understanding of and
ability to forecast overall inflation? Relatedly, should we look to inflation models with
nonlinear or threshold effects, which could capture, among other things, supply
constraints? The pandemic has had a much more prolonged effect on labor supply than
many expected, and rapid nominal wage growth has accompanied the recent rise in
inflation in ways that traditional measures of labor market tightness-such as the
unemployment rate gap-might not be capturing. Many analysts have used data on job
vacancies to go beyond a simple unemployment rate gap indicator, and I see merit in such
approaches. We should ask how we can better understand the relations among
realizations of inflation, inflation expectations, and the rate of inflation to which the
economy would gravitate after the effects of temporary shocks have ebbed. Finally, we
should consider if there are ways to better anticipate structural breaks in the inflation
process. For example, inflation could become a nonstationary time-series process if
inflation expectations were to become de-anchored.
The responses to these questions lie in further research-research that will be
made richer, more useful, and, hopefully, easier if we expand our data sources to include
more real-time and other novel indicators. When the economy is disrupted by a once-in-
a-century event, there is no such thing as too much data and too much analysis.
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Thank you.