Dec 19  Jun 20  Dec 20  80 Jun 21  Sources: OECD Quarterly National Accounts, IMF World Economic Outlook and Bank calculations. Across the advanced economies in aggregate, spending on services in first quarter of the year was 5% lower than at the end of 2019; spending on goods was 5% higher (Chart 7). Shifts in demand happen all the time and, as long as supply can shift in response, they needn’t have any impact at the macro-economic level. But this one was far larger, more widespread and occurred much faster than most. And, far from shifting in response, and meeting that extra demand, the pandemic meant the global supply of goods was actively impaired. Local lockdowns affected production in many Asian countries and effective capacity in shipping and other forms of transport was also hit. Earlier this year my own guess was that these things would visibly start to reverse by the end of it. Because they were caused by the pandemic it was reasonable to expect the shifts in demand to reverse, and the problems in supply chains to abate, as vaccinations took effect. As yet it’s clear that hasn’t happened to the degree that I, at least, expected. Shipping costs remained very high throughout the autumn; as we’ve seen, energy (and particularly gas) prices took a huge lurch upwards; at the retail level there is no sign yet of any deceleration in goods prices.
This is in the nature of what’s called a “trade-off-inducing” shock, one that pushes the primary objective of policy (stabilising inflation) in one direction, the secondary objective (stabilising demand and employment) in the other. These things crop up all the time, to one degree or another. Prices of imports (especially energy) are volatile; slowdowns in productivity growth, which are common enough, can sometimes have the same effect10; so can rises in excise duties or VAT. But, in reality, these things rarely have much of a bearing on policy because, very often, their impact on inflation doesn’t last long enough. Changes in interest rates take time to work. And if a shock to inflation is gone before monetary policy could do anything to offset it there’s not much point in taking action. This hasn’t always been the case. After the Brexit referendum, for example, the MPC judged that the inflationary consequences of the big drop in sterling’s exchange rate probably would last long enough to matter at the “policy horizon” (as had been the case after the financial crisis). The Committee therefore had to balance this effect against the fact that, for much of that period, the economy was operating with a degree of space capacity. There’s a good chance that this shock too, larger though it is, will have dissipated by the time a policy decision taken now could take effect. Indeed it’s quite possible that, in a couple of years, some of these tradable goods prices will be falling, pulling down on inflation.