Supply Constraints and Inflation Dynamics

This paper analyzes the impact of supply constraints on inflation dynamics and its mechanisms from both empirical and theoretical perspectives. It also examines recent changes in the relationship between supply constraints and inflation dynamics, as well as measures to mitigate the effects of supply constraints on inflation. The analysis shows that the recent intensification of supply constraints affected Japan's inflation dynamics through the following channels. First, the intensification of labor and material supply constraints had a persistent impact on the inflation rate through mechanisms such as factor price increases. Second, the intensification of labor supply constraints contributed to the recent increase in inflation through nonlinear effects which amplify the demand elasticity of prices. The results also suggest that persistent supply constraints, under accommodative financial conditions, led to a recent rise in inflation expectations. Furthermore, the analysis implies that inflationary pressures arising from intensifying supply constraints have become more frequent and significant in recent years. The further intensification of labor supply constraints could have a nonlinearly strengthening effect on inflationary pressures in the future. Promoting technological progress through firm-based initiatives and government policies-such as the adoption of AI-and facilitating labor mobility across industries and firms, will be important for easing supply constraints in Japan.