Demand Pull Inflation Defined

Demand Pull Inflation is a phenomenon where too many dollars are chasing too few supplies.  In classical economics, if there is a surge in incomes, with a coincidental surge in expenditures, the push upward in demand will exasperate supply.  And, as suppliers work to replace the already sold items into inventory, these suppliers will have to compete for limited supplies.  Price will rise in this environment.  And, inflation will ensue, creating demand pull inflation.  And, there is the possibility of stagflation if wages decline.

Currently, we are in an environment where there is demand pull inflation.

COVID & Demand Pull Inflation

PCE Inflation is heading upward Showing Demand Pull Inflation

Prior to COVID, the supply chain worked on an on-demand basis.  As consumers bought products, this prompted retailers to continually order products that were sold.  Retailers kept a certain, average,  and static amount of supplies on their store shelves.

As retailers needed to replenish inventories, they would turn to suppliers for more supplies and distributors.  These suppliers would in turn order more supplies from producers.

Producers would then, order raw materials to produce whatever products were needed to manufacture their respective products.  This on-demand supply chain worked in an environment with continued consistency.

Retailers knew on average what was normally necessary to order.  And, suppliers and distributors would be able to order and distribute those supplies on an on-demand basis knowing that there was a sufficient stream of products available.

And, producers, who were accustomed to a normal flow of orders would require a certain, and consistent, quantity of raw goods to produce what they would use in any given economic environment.

COVID broke the supply chain

When COVID hit, the world effectively shut down.  This meant that raw goods producers were producing less products.  And, producers, not being able to get the necessary raw materials to produce their respective goods, saw declining production.

Simultaneously, suppliers and distributors also saw breakdowns in their own ability to distribute to retailers because of the lockdowns and breaks in the supply chain.

Finally, retailers have been unable to continually keep up with demand from consumers as the supply chain, often coming in shipping containers from China, are backlogged in ports that are behind by some 3, 6, or up to 9 months at any one time.

Because of the breakdown in the supply chain, retailers, desperate to replace their shrinking inventory, started bidding up products from supplies that were limited.  This drove prices upward, creating inflation.

Stimulus Checks & Demand Pull Inflation

Personal Incomes moved higher with the stimulus checks driving demand pull inflation

Then came the stimulus checks.  The stimulus checks issued to Americans who earned less than a certain amount on an individual and family basis, showed up and Americans promptly did what they did best: Shopped.

As you can see in the charts above for personal incomes, there were sharp increases[1]Data from Bureau of Economic Analysis

In an environment where there was a breakdown in an on-demand supply chain, limiting supplies available, the influx of such a large amount of income that otherwise would not have existed, and the subsequent shopping spree that ensued, this exasperated an already over-burdened supply chain.

Because of the large increase in incomes, and coincidental expenditures by consumers in the United States, the supply chain became over taxed to keep up with demand.

In any classical economics environment, this kind of pressure on the supply chain would create price pressures.  And, considering the magnitude of the increase in incomes and expenditures, it is no wonder that inflation hit 40-year highs.

Increases in incomes & expenditures

Personal Expenditures is moving upward from stimulus checks

In any normal year, if there is an increase in about 2.5% or 5% in incomes, this may translate into increases in expenditures that are similar or higher.  With those kinds of increases, the economy could expecT anywhere from 2.5% – 5% in increases for expenditures.  They are non-linear.  But, they are highly correlated.

However, and very suddenly, Americans received a significant raise in incomes that was out of the ordinary.  The stimulus checks drove incomes upward with an initial spike of 7.5% and then an additional spike of 14% on a year-over-year basis.

These big spikes upward in incomes coincided with increases in expenditures that reached over 15% on a year-over-year basis change.

Effectively, there were expenditures of an extra 10% more than what was normal.

COVID & Federal Reserve Stimulus

Along with the stimulus checks, the Federal Reserve stepped in and injected an enormous amount of liquidity into the system ensuring that there was enough lubricant to perpetuate the economy.

One of the steps the Federal Reserve took was to lower interest rates.  This enabled borrowing costs to drop to near zero maintaining a low-pressure environment on consumers.  This enabled many consumers to continue with expenditures because borrowing costs were below normal.

Interest rates on credit card debt, auto loans, student loans, and mortgages were maintained at historically low levels.  Consumers took advantage of this and through expenditures helped maintain a very robust economic environment.

The broken supply chain

However, this “very robust environment” was also simultaneously being maintained during a period where there was an exacerbated and broken supply chain.

Another step that the Federal Reserve took was to increase its balance sheet to extraordinary levels.  This allowed for liquidity pressures to dissipate as the Federal Reserve took over the liquidity demand of many players within the economy.

By doing this, those that would otherwise have bought certain instruments, such as 10-Year Treasury Notes or mortgage debt, needed to buy alternative debt instruments.  This allowed for additional liquidity throughout the world economies.

Broken Supply Chain, Increased Expenditures, & Demand Pull Inflation

If, in an environment where there is a broken down supply chain as we have seen with the COVID-induced lockdowns, this will break the supply chain.  Simultaneously, there was a tremendous amount of liquidity induced into the system by the Federal Reserve.  And, then there were the stimulus checks.

All of these factors played in to a historical rise in inflation.  This is Demand Pull Inflation and the reason that there was a big increase in inflationary pressures over the past several months.

And then war broke out

The war in Ukraine, and subsequent sanctions on Russia, are exacerbating an already broken system.  The two big factors here are food prices from the drop in food supplies from Ukraine as well as a drop in oil supply will play out across the globe.

Although we have seen some immediate effects of price increases because of the sanctions and drop in food supplied from the world’s biggest grain exporter, more will come.  The fallout from this will trickle through for a very long time.

Look for continued inflationary pressures and the ripple effects throughout the economy.


1 Data from Bureau of Economic Analysis

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