Supply chain disruptions and shipping delays have often been blamed for the rise in US inflation since COVID-19 hit. For instance, a recent note from the Federal Reserve Bank of San Francisco concluded that supply factors account for around half of the inflation run up in the US economy, dwarfing demand factors. For imported goods, however, demand is equally if not more responsible. Prices have risen (blue line) but import quantities have also grown faster than before the pandemic (black line), implying strangled supply chains are not the sole driver of US inflation.
If supply chain disruptions were solely to blame for these sharp price rises, import quantities would have remained flat or fallen. That has not been the case. More goods are arriving in the US and prices are still rising, indicating higher consumer demand must be at least partly to blame.
Consumers shifted their spending away from services during the pandemic as businesses closed, workers moved to remote working arrangements, and the government fiscal response temporarily raised disposable incomes, allowing households to make “big ticket” purchases like home appliances, exercise equipment, and electronics. This surge in demand led to faster import growth, peaking in May 2021 at a 40 percent increase from the previous year.
This sharp increase in demand also put upward pressure on prices. In every month since April 2021, prices have grown by more than 8 percent compared with the previous year, reaching a peak of 12.2 percent growth in March 2022.
Correctly identifying the role supply and demand play in driving prices higher is essential for understanding the effect of policy interventions. If supply is so constrained that it is essentially fixed, tighter monetary policy could reduce demand and bring prices down with only a small change in supply and hence economic conditions could be relatively stable. In contrast, if strong demand is driving inflation, constraining it will reduce both output and prices, increasing the risk of recession.
Moreover, since the focus here is trade, the potential for tariff reduction (or similarly dollar appreciation) to ease inflation depends on whether imports can expand. While lowering tariffs boosts competition and depresses prices in the long term, it is more suited to constraining short-run inflation caused by strong demand. For products where supply is at capacity, tariff reduction is unlikely to be passed on to consumer prices because that would generate additional demand that cannot be met.
This PIIE Chart is based on Caroline Freund’s Policy Brief, Soaring demand is driving double-digit import price inflation in the United States. Produced and designed by Nia Kitchin and Oliver Ward.