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What drives inflation? Disentangling demand and supply factors

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  • Eickmeier, Sandra
  • Hofmann, Boris

Abstract

We estimate indicators of aggregate demand and supply conditions based on a structural factor model using a large number of inflation and real activity measures for the United States. We identify demand and supply factors by imposing theoretically motivated sign restrictions on factor loadings. The results provide a narrative of the evolution of the stance of demand and supply over the past five decades. The most recent factor estimates indicate that the inflation surge since mid-2021 has been driven by a combination of extraordinarily expansionary demand conditions and tight supply conditions. We obtain similar results for the euro area, but with a somewhat greater role for tight supply consistent with the greater exposure of the euro area to recent adverse global energy price shocks. We further find that tighter monetary policy and financial conditions dampen both demand and supply conditions.

Suggested Citation

  • Eickmeier, Sandra & Hofmann, Boris, 2023. "What drives inflation? Disentangling demand and supply factors," CEPR Discussion Papers 18378, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18378
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    2. Binetti, Alberto & Nuzzi, Francesco & Stantcheva, Stefanie, 2024. "People’s understanding of inflation," Journal of Monetary Economics, Elsevier, vol. 148(S).
    3. Lilian Muchimba & Mimoza Shabani & Alexis Stenfors & Jan Toporowski, 2024. "Decomposing the Rate of Inflation: Price-Setting and Monetary Policy," Working Papers in Economics & Finance 2024-04, University of Portsmouth, Portsmouth Business School, Economics and Finance Subject Group.
    4. Casoli, Chiara & Manera, Matteo & Valenti, Daniele, 2024. "Energy shocks in the Euro area: Disentangling the pass-through from oil and gas prices to inflation," Journal of International Money and Finance, Elsevier, vol. 147(C).
    5. Speck, Christian, 2023. "Pricing the Bund term structure with linear regressions – without an observable short rate," Discussion Papers 08/2023, Deutsche Bundesbank.
    6. Serdar Kabaca & Kerem Tuzcuoglu, 2023. "Supply Drivers of US Inflation Since the COVID-19 Pandemic," Staff Working Papers 23-19, Bank of Canada.
    7. Clodomiro Ferreira & Stefano Pica, 2024. "Household perceptions of the sources of business cycle fluctuations: a tale of supply and demand," Temi di discussione (Economic working papers) 1441, Bank of Italy, Economic Research and International Relations Area.
    8. Todd E. Clark & Matthew V. Gordon, 2023. "The Impacts of Supply Chain Disruptions on Inflation," Economic Commentary, Federal Reserve Bank of Cleveland, vol. 2023(08), pages 1-8, May.
    9. Khazan Bakhshaliyev & Vugar Ahmadov, 2025. "Decomposition of inflation in Azerbaijan into supply and demand components according to supermarket data," IHEID Working Papers 12-2025, Economics Section, The Graduate Institute of International Studies.
    10. Jean-Marie Le Page, 2024. "Pure Theories of Policy Mix : Nordhaus's Destructive Game and the Case of High Inflation," Review of Economic Analysis, Digital Initiatives at the University of Waterloo Library, vol. 16(1), pages 1-18, March.
    11. Gert Peersman, 2025. "Understanding Post-Pandemic Inflation Fluctuations: The Commodity Cost Channel," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 25/1123, Ghent University, Faculty of Economics and Business Administration.
    12. Ferrari Minesso, Massimo & Van Robays, Ine & Cassinis, Maria Giulia, 2025. "Supply shocks and inflation: timely insights from financial markets," Working Paper Series 3096, European Central Bank.
    13. Alex Twinomuhwezi & Benjamin Musiita & Frederick Nsambu Kijjambu, 2025. "Macro-Financial Determinants of Electricity Power Loss in Uganda," Journal of Economics and Behavioral Studies, AMH International, vol. 17(1), pages 96-107.
    14. Matthew Read, 2024. "Sign Restrictions and Supply-demand Decompositions of Inflation," RBA Research Discussion Papers rdp2024-05, Reserve Bank of Australia.
    15. Solikin M. Juhro, 2023. "Future Central Banking In Emerging Market Economies," Working Papers WP/01/2023, Bank Indonesia.
    16. Hassan Faryaar & Danny Leung & Alexandre Fortier-Labonté, 2023. "Markups and inflation: Evidence from firm-level data," Economic and Social Reports 202300600004e, Statistics Canada, Analytical Studies and Modelling Branch.
    17. Nickel, Christiane & Kilponen, Juha & Moral-Benito, Enrique & Koester, Gerrit & Ciccarelli, Matteo & Enders, Almira & Holton, Sarah & Landau, Bettina & Venditti, Fabrizio & Bobeica, Elena & Brand, Cla, 2025. "A strategic view on the economic and inflation environment in the euro area," Occasional Paper Series 371, European Central Bank.
    18. Garcia-Revelo, José & Levieuge, Grégory & Sahuc, Jean-Guillaume, 2025. "Revisiting 15 years of unusual transatlantic monetary policies," Journal of International Money and Finance, Elsevier, vol. 159(C).
    19. Clodomiro Ferreira & Stefano Pica, 2023. "Household Perceived Sources of Business Cycle Fluctuations: a Tale of Supply and Demand," Working Papers 287, Red Nacional de Investigadores en Economía (RedNIE).

    More about this item

    Keywords

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    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables

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