Supply Chain's Increasingly Important Role in Monetary Policymaking
on Jan 6, 2022
The Fed's balancing act (growth/full employment vs. inflation) requires them to forecast where the economy is headed. The state of national and global supply chains is an increasingly important piece of that puzzle.
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Recently the folks at the Fed are feeling the pain that supply chain planners have felt since ‘the dawn of supply chain planning’. Forecasting the future of global supply chains is just really hard. Not that the Fed’s job has ever been that easy, especially during times of financial crisis. It has just been made harder by the supply chain disruptions and shortages this year.
The Federal Reserve (the Fed) has a dual mandate from congress of achieving both maximum employment and price stability at the same time. In this balancing act, they have to consider many things such as the current and projected rate of inflation, current and projected employment, expected federal fiscal policy actions and their effect, asset valuations and risk appetite, leverage in the financial system, funding risk, commercial and household debt levels, global economic factors, and more. Now you can add the state of the supply chain to that long list. Historically supply chain constraints have played a relatively secondary role in the Feds overall deliberations. Recently, the ability of the supply chain to ‘deliver the goods’ has become a key part of the Fed’s prognostications.
In the past, supply chain bottlenecks were usually limited to one part of the economy and often short-lived. What’s different this time is the breadth, depth, and duration of the disruptions and the mismatch between demand and supply. Shortages and delays have been seen economy-wide, world-wide in everything from oil to ketchup to shipping capacity, semiconductors, cars, truck drivers, warehouse space, tractor-trailer chassis, agricultural commodities, metals, plastic, textiles … you name it; it seems like almost everything is in short supply.1
The Perfect Storm for Supply Chain Disruption
The pandemic and other issues have converged to cause huge shortages and delays in supply chains:
Amped up demand for ‘things’—Since the pandemic started, people are buying more stuff. The money they had been spending on dining out, traveling, going to the theater or ball game, and other in-person experiences before the pandemic is now being spent instead on buying more physical products. As people were spending more time at home, they upgraded their homes with new gadgets, appliances, exercise gear, and home improvements. Demand surged way ahead of the ability for existing manufacturing plants to produce. New housing demand has also exploded, as remote workers no longer need to live close to the office in an expensive cramped city apartment and are opting instead to buy a home in the suburbs or in a less-expensive city. Builders and building material suppliers have not been able to keep up.
Pandemic-induced inefficiencies—In the early pandemic, many factories were outright shut down. China continues to shutter factories in their efforts to achieve zero COVID. Even after they have been reopened, factories, distribution centers, and other facilities experience on and off requirements for social distancing, temperature checks, more frequent equipment cleaning, and other precautions that erode the efficiency of production lines, warehouse operations, and ports. This effectively reduces the capacity of global production and supply chains.
Labor shortages—The Big Quit, The Great Resignation, The Great Renegotiation … whatever you call it, workers are quitting jobs in unprecedented numbers and demanding more from their employers. Power has shifted to workers and labor shortages have become acute. The omicron surge will cause even more workers in jobs that expose them to potential infection to decide its finally time to try a different career path. Whatever the reasons, unprecedented numbers of workers are leaving their jobs. On top of that, people are out sick with COVID, further exacerbating labor shortages. For example, today alone, 2,600 flights were cancelled due primarily to airline crews out sick with COVID.
Extreme weather events—Hurricanes, floods, wildfires, droughts, deep freeze winter storms, derechos, and other extreme weather events were at record highs this year, causing further disruptions to harvests, production, and transportation.
How Soon Will All of This Be ‘Fixed’?
Altogether these factors created a ‘perfect storm’ for supply chain disruption and demand/supply imbalance. Normal market forces will correct many of these imbalances over time … some faster than others. It takes time and capital2 to build new production lines or hire more workers. Many manufacturers are reluctant to overinvest for the current surge, fearing that the increased demand may very well be temporary. As people return to in-person activities, their spending will shift back to experiences and away from physical products, though predicting how quickly this happens is difficult, as it depends on the course of the pandemic, what new variants emerge, and most unpredictably, people’s behavior and attitudes. Some changes may be longer lived, such as working from home and the lifestyle/purchasing behavior changes that entails.
Pandemic-induced inefficiencies will linger as long as the pandemic is here. The rapid emergence and staggering growth rate of the omicron variant has shown how hard it is to predict what is coming next. Is omicron the last gasp of the pandemic, transitioning to an almost normal endemic phase in mid-2022? Or will even more transmissible and possibly more virulent variants yet emerge this year or beyond? There doesn’t seem to be consensus among epidemiologists yet.
Regarding labor shortages, we have already seen historic increases in wages and other actions by companies trying to attract and retain workers. Those actions have not solved the labor shortage, but over the coming year (or years) companies will figure out what they have to do to get the workers they need. The future of extreme weather events is a bit easier to predict (in aggregate, not individually) as climate change is only going to get worse for the next few decades and we can expect more of these disruptions. However, weather-related disruptions during the pandemic were probably the least impactful of the four factors listed overall, so once the other three are ‘solved’, the shortages should largely abate.
The Fed Has Placed Its Bet … For Now3
The Fed’s monetary policy balancing act tries to build and maintain full employment while controlling inflation. The capacity of the supply chain to 'deliver the goods' plays a key role in inflation. When capacity constraints create supply shortages, prices go up. When there is just enough supply, prices stabilize. If supply overshoots demand, prices fall. Hence the Fed finds itself trying to consider all of these nearly impossible to predict factors and envisage when and at what speed global supply chains and consumer demand will rebalance. Based on the Fed’s recent mid-December announcements, it seems they are betting that shortages will not ease soon. They are taking inflation more seriously and speeding up the transition to tighter monetary policy. Only time will tell whether they are taking the right actions in the right time frame.
2 For example, a new semiconductor fab cost $2B to $20B and takes years to build. Chip shortages cannot be solved overnight. -- Return to article text above
3 Whatever ‘bet’ the Fed places, it revisits every month. Its current position and projected actions are a snapshot in time, that evolve as conditions change. The Fed does not, however, make changes to past promises or projections lightly or willy-nilly. It tries to provide continuity and predictability in its actions so as not to rattle markets. -- Return to article text above
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