Bottlenecks and monetary policy
The world economy has been largely driven by a pandemic cycle since early 2020. In spring 2020, there were major concerns about the near and medium-term prospects for the world economy due to the severe economic dislocations caused by the spread of the virus and the societal and public health responses to it. In this initial phase, there was a large decline in global economic activity and many investment and production plans for 2021 and beyond were downgraded or cancelled. The significant recovery in the third quarter of 2020 and, most importantly, the rollout of vaccine programmes since late 2020 has led to a faster-than-anticipated recovery, while the success of fiscal policies in protecting the incomes of households and firms has further reinforced global demand conditions.[2]
At the same time, the recovery has necessarily been quite asymmetric. Social distancing has continued to constrain demand and activity levels in high-contact services sectors and the relative expenditure switch towards the consumption of goods has constituted a substantial sectoral shock. In addition, manufacturing production has continued to be disrupted by the shocks to labour supply and temporary factory shutdowns that have been generated, among other factors, by infection clusters and virus containment measures around the world.[3]
The combination of all these factors has resulted in many types of supply-demand mismatches. These have been compounded by the nature of global supply chains, with a disruption in one part of the chain cascading both upstream and downstream. An additional amplification mechanism has been the bullwhip effect by which ordering strategies along the value chain adjust in a nonlinear manner to demand shocks from customers and supply shocks from input providers.
In the specific context outlined above, I will use the term bottleneck to refer generically to a supply-demand mismatch. Under typical circumstances, an unexpected increase in demand or an unexpected loss of supply capacity will quickly invite the creation of new supply capacity and the entry of new suppliers and, through relative price adjustment, the rotation of demand towards substitute categories. However, the common and global nature of the pandemic has meant that, in any given industry, potential alternative suppliers have all faced similar constraints. Moreover, the option to switch demand away from goods and towards services has been severely limited by the impact of the pandemic on both the desire to consume and the ability to supply contact-intensive services. Under the atypical circumstances of the pandemic, large and sudden surges in sectoral demand or declines in sectoral supply are difficult to resolve in a speedy, smooth or gradual manner. This gives rise to delays in production and sales processes throughout the supply chain and jumps in relative prices.
It is important to recognise that the patterns of supply/demand mismatches seen during the pandemic have been extremely rare in history. While the combination of a sudden demand shortfall and an overhang of excess supply has been generated by financial crisis episodes, the reverse is rarely seen. Prior case studies that may be seen as relevant for understanding what is going on today are the post-war reopening episodes, when demand decompressed and firms had to retool and switch from production of military equipment back to consumer goods.
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