Decomposing Supply‐ and Demand‐Driven Inflation

Abstract The extent to which either supply or demand factors drive inflation has important implications for economic policy. I propose a framework to decompose inflation into supply‐ and demand‐driven components. I generate two new data series that quantify the degree to which either demand or supply is driving inflation in a current month. The demand‐driven contribution tends to decline during recessions, while the supply‐driven contribution tends to follow food and energy prices. Monetary policy tightening acts to reduce the demand‐driven contribution of inflation. Oil‐supply shocks act to increase the supply‐driven contribution, but decrease the demand‐driven contribution of inflation.