Nobel Laureate Urges Supply Side Push vs Inflation

The efforts of central banks to curb high and rising inflation are exacerbating growth headwinds and threatening to send the global economy into recession. A substantial, broad-based, and persistent mismatch between supply and demand is the immediate cause of today's inflationary pressures.

Photo Insert: Nobel economics laureate Michael Spence

Higher interest rates will dampen demand, but supply-side measures must also play a significant part in inflation-fighting methods, Nobel economics laureate Michael Spence stated in an essay for Project Syndicate.

The rollback of pandemic-containment policies over the last year or so has resulted in an increase in demand and a loss in supply. While this was predictable, supply has been shockingly inelastic.

Labor shortages, for example, have become the norm, resulting in canceled flights, interrupted supply chains, restaurant closures, and health care delivery issues.

These shortages appear to be the outcome of a pandemic-induced shift in preferences. Many sorts of workers want more flexibility, including hybrid or work-from-home possibilities, as well as better working conditions. Workers in the health care industry, in particular, report feeling burned out. If this is correct, the inflation picture must account for a change in relative labor costs.

Wage and income increases will be required to restore market balance, especially for jobs where there was previously a sufficient supply of workers. This transition will result in some inflation. Yes, nominal prices and wages have a limited ability to fall. However, in times of excess demand, corporations often try to pass on greater costs through price rises — and they frequently succeed, at least for a while.

Lingering pandemic-related delays are also fueling inflation, particularly in China, which has maintained its zero-COVID policy.

However, these bottlenecks will eventually disappear, as will short- to medium-term capacity restrictions caused by variations in demand composition (in terms of both products and geography), though some will remain for some time. Building capacity, whether in ports or chips, takes time.

Today's inflation, though, has deeper origins. Activating large amounts of unused labor and productive potential in emerging economies has resulted in deflationary pressures over the last several decades. Because those resources have already been reduced greatly, the relative costs of many items are expected to rise.

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