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Almost every time I see an expert interviewed on the macroeconomy, they suggest that a substantial portion of the inflation over the past 5 years has been supply side. That’s wrong; none of it has been supply side. I’d go even further; essentially none of the inflation over the past 50 years has been supply side.

To be clear, I am speaking of the total cumulative increase in prices over 5 years, or over 50 years. It is true that some of the inflation in 1979 was supply side, as well as some of the inflation during 2008, or 2022. There have been individual years where negative supply shocks pushed up prices, but just as many years where positive supply shocks pushed down prices.

Many experts implicitly seem to think there’s some sort of “ratchet effect”, where negative supply shocks push up prices, and then inflation settles back to its average rate. That’s false. When negative supply shocks are not causing inflation to rise above average, positive supply shocks cause it to fall below average.

West Texas crude currently trades at just over $70/barrel. The graph below shows real oil prices over the past 80 years (deflated by the CPI):

Adjusted for inflation, oil prices are about the same as they were in the late 2010s, and about the same as they were in the mid-1970s. That means that the nominal price of oil has risen at roughly the same rate as the overall CPI over the past 5 years, and indeed over the past 50 years. Oil doesn’t explain long run inflation at all.

[To be fair, there was a permanent one-time rise in real oil prices during 1973, when the OPEC moved the industry from being a competitive market to a cartel. Since then, it’s been mostly fluctuations round a real price of about $70/barrel.]

When oil prices rise faster than the CPI, it puts upward pressure on the CPI. Technically, the Fed could prevent this, but due to its dual mandate it generally allows higher oil prices to pass through to higher consumer prices. When oil prices rise slower than the CPI, it puts downward pressure on the CPI. Because oil prices have risen at roughly the same rate as the CPI over the past 5 years, and even over the past 50 years, oil shocks have had essentially no long run impact on the cost of living. None. The same is true of food price shocks, supply chain shocks, and other types of supply shocks. They are a non-factor for long run inflation.

So why do so many experts insist that supply shocks played a big role in the unusual inflation over the past 5 years? They seem to have made the following error. They correctly observed that negative supply shocks pushed consumer prices higher during 2022, but forget to note that positive supply shocks had an equally powerful downward effect on inflation during other recent years. In other words, the supply shock part of the problem really was transitory. 

So why wasn’t the overall inflation rate transitory, as many had predicted? The answer is simple. All of the cumulative inflation since 2019 is demand side, and demand side inflation is permanent. PCE inflation over the past 5 years has exceeded the Fed’s 2% target by a total of nearly 8%. NGDP growth has exceeded 4%/year by a total of roughly 10%. That’s the entire problem—supply shocks have nothing to do with it. If anything, we’ve had enough positive supply shocks (mostly immigration) to hold inflation 2% below the level you would expect from the extreme demand stimulus that was provided. The Fed actually got lucky.

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