Typically, potential output is divided into a contribution from the stock of capital – how much physical capacity there is in the economy – and something called “total factor productivity”, or TFP. The stock of capital is much bigger than the flow of new investment that adds to it, and it therefore evolves relatively slowly. And, while TFP is a catch-all for all sorts of factors, many associate it with relatively slow-moving things like the state of technological knowledge or average educational attainment. On this basis it’s hard to see how the overall rate of potential output growth – and, a fortiori, our estimates of that trend – could change much over any short period of time. Indeed, I think we can go further than this – not only can the view that changes in supply are gradual make sense in principle, I think it’s usually true empirically as well. Over shorter-run cyclical horizons, most movements in economic growth appear driven by demand, not supply. That’s why inflation tends to be higher in upturns than downturns. But that doesn’t mean such short-term hits to productivity are inconceivable. We saw a sharp step down in productivity growth after the financial crisis. And I think there are things involved in Brexit that, once one digs below the macro-economic surface, could potentially do the same. I’m thinking in particular of allocative effects.
We may see now that in recent months the proinflationary impact of demand has become prevailing. The fundamental difference of the so-called ‘cost inflation’ from ‘demand inflation’ is how it influences the physical volumes of consumption. In case of ‘cost inflation’, that is, supply shock, prices are growing, but consumers have to buy less in response. Businesses can only partially translate their costs into prices, as demand is limited. Whereas, if both prices and sales volumes grow, and this is exactly what we are seeing now across quite a few market segments, it means that the expansion in demand is by far exceeding the impact of supply-side factors. Therefore, it means that we are facing ‘demand inflation’. Finally, elevated inflation expectations do make a considerable contribution to inflation. In anticipation of price increases, consumers are ready to start buying earlier than they previously planned. Thus, given the unanchored expectations even transitory price spikes may become more sustainable. Why is the acceleration of inflation posing a threat? It is more difficult for companies to stick to their business plans, predict financial flows, and hedge against volatility. It is the most vulnerable citizens that are hardest hit by inflation. Low-income families spend increasingly more funds on essential goods. High inflation boosts inequality, lowers social security, and undermines the financial standing of most families. That is why our main task is to stabilise price growth 2/4  BIS central bankers' speeches  as soon as possible by curbing inflation expectations and not allowing inflationary spiral to exacerbate.