The Need for More Resilient Supply Chains

This 11-minute podcast was released Aug. 17, 2022, as a part of the Timely Topics podcast series.

"How can firms and how can governments internalize uncertainty of a future shock and what can they do today to hedge the risks of something happening in the future?" asks Ana Maria Santacreu, research officer at the Federal Reserve Bank of St. Louis, in her latest discussion about supply chain disruptions and producer price index inflation. Santacreu talks with Maria Hasenstab, media relations coordinator at the St. Louis Fed, about her research on supply chains.

Transcript

Maria Hasenstab: Welcome to the St. Louis Fed's Timely Topics podcast series where we interview economists about their research. I'm Maria Hasenstab, your host. In this episode, we'll be discussing supply chain disruptions and inflation with Ana Maria Santacreu, a research officer at the Federal Reserve Bank of St. Louis.

Ana Maria Santacreu: Thanks for having me.

Hasenstab: The COVID-19 pandemic caused supply chain disruptions, and we all know that now. But, remind us what those disruptions looked like at the onset of lockdown in spring 2020, how those disruptions evolved throughout the pandemic, and then, bring us to what those disruptions look like now, our current situation.

Santacreu: Yeah. So, the pandemic has changed the patterns of consumption in a way that we have not seen in previous recessions. So, first, as you were saying, there were lockdowns, and there was fear of contagion. So, people were not going to eat out in restaurants. There was less traveling, and at the same time, governments were giving strong fiscal support to consumers. And, part of those checks were spent on durable consumptions. So, for example, there was work from home, and then, people were buying desks. They were buying chairs to set up their home office. They were buying fitness equipment. They were buying video games. So, what we experienced was a change in the composition of consumption away from services and toward durable goods.

Hasenstab: Yes. People stopped going out to eat, but you're right. They had to build their home office, and they weren't going to the gym. So, they might have bought a treadmill or an exercise bike.

Santacreu: Exactly, and that's something that we haven't experienced in previous recessions. So, during a typical recession, the consumption of services doesn't move mostly, but the consumption of durable goods declines and then it's starts recovering until it gets back to the initial level. What we saw in the current pandemic is that there was a huge drop in the consumption of services. As you were saying, people were not going out, and it hasn't recovered yet. Whereas, the consumption of durable goods declined at the beginning of the pandemic, like in a typical recession, but then, it started increasing dramatically. And today, consumption of durable goods is 40% above of what it was in February of 2020.

Hasenstab: People are spending more on those products than they were even before lockdown.

Santacreu: That's right. So, it's not only that there is a huge increase in the demand of goods. It's that there is a huge increase in the demand of durable goods. Now, what is special about durable goods? So, the production of durable goods is organized in what is called supply chains. So, instead of producing all the goods and all the components of the goods in one factory, what firms do is they source some of their inputs from other firms that are located in different countries. So, what that means is that, if there's any shock that affects a firm in a particular country, those shocks are going to be propagated along the supply chain and are going to affect the final producer. So, think, for example, of a manufacturer of cars. To produce a car, we need about 30,000 components, and all these components are not produced by the same car manufacturer. These components are produced by different firms that are located in different countries, and, at the same time, these components need inputs. So, for example, a fairly critical input in the production of components that go into a car are semiconductors, and during the pandemic, we experienced a big global shortage of semiconductors that were affecting the production of the components that then they go to the production of a final car. Right?

Hasenstsab: So, you couldn't build the car because there weren't enough semiconductors.

Santacreu: That's right. So, now, we have this huge increase in the demand of durable goods, partly like cars, but production was slow to adjust because there were disruptions along some status in the production process. There were lockdowns, and then, there was this huge increase in the demand for these goods. So, what we experienced was a mismatch between demand and supply, and that mismatch caused an increase in prices. And, this mismatch between demand and supply was not transitory, something that we have seen happening during the past two years, and that has led to increases in prices and to inflation.

Hasenstab: So, when you talk about inflation, let's define what kind of inflation you're looking at and how that affects these industries and firms.

Santacreu: So, the type of inflation that I'm studying in my research at the St. Louis Fed with my research associate Jesse LaBelle is an increase in the producer price index. The producer price index basically reflects the cost of production of a firm. So, if now the inputs of production are more expensive, then the firm or the sector is going to experience an increase in producer price inflation, and what we find in our research is that those industries in the U.S. that were more exposed to foreign bottlenecks through supply chains experienced higher increases in producer price inflation.

Hasenstab: So, to go back to your example with the car industry, most of the pieces come from?

Santacreu: From China, Canada and Mexico.

Hasenstab: OK.

Santacreu: Right. And, these were, so especially China was a country that experienced very strict lockdowns. There were supply chain disruptions in China. So, the motor recoil industry in the U.S. was very exposed because a big fraction of what the sector is producing is produced within what's from China, and also, it was very exposed because China was suffering big supply chain disruptions. So, what we find is that the motor vehicle industry experienced large increases in producer price inflation. So, car manufacturers now had to input goods that were more expensive, so the cost of productions were increasing. And, it was not only the motor vehicle industry. Other industries that were very exposed were basic metals and energy. So, in general, what we find is a strong correlation between how exposed an industry is because it's importing a lot but also because it's importing a lot from countries that are suffering supply chain disruptions and PPI inflation in those industries.

Hasenstab: So, because of the disruptions and PPI inflation, the auto industry now -- the end product -- are costing more.

Santacreu: Right. So, our research is about what is the effect of the exposure has on the producer price inflation, so in the cost of production of the motor vehicle industry. Now, to the extent that producers in the motor vehicle industry are going to pass through some of these increases in production onto the consumers, then we're going to experience an increase in CPI inflation, which is inflation of a basket of goods that the consumer is buying.

Hasenstab: Okay. That is so helpful. So, moving forward, we know that you are studying PPI inflation, which is how much the industry is paying more to build the automobiles, for example.

Santacreu: That's right. Yes.

Hasenstab: Perfect. Now, let's take a quick break.

The Federal Reserve Bank of St. Louis invites you to hear from women who are making their marks in the field of economics. In our Women in Economics Podcast Series, we host one-on-one conversations with economists, professors, journalists, business leaders, and other influential women who have studied and are working in the field of economics. You can find all our Women in Economics Podcast Series episodes on stlouisfed.org or wherever you're listening.

Hasenstab: And now, back to our conversation with Ana Maria about supply chain disruptions.

Now, let's look to the future. We are about halfway through 2022. What are the challenges ahead thinking about supply chain disruptions and inflation?

Santacreu: So, I think the biggest challenge ahead is how to design policies today that are about facing disruptions when the next shock hits. So, today, what we see is a large increase in the demand of durable goods. The production of these goods was slow to adjust because there were lockdowns, because there was a crisis in the shipping sector, but tomorrow, this shock may look very different. And, where I think this pandemic has taught us is that this is not a one-time shock. The shocks are becoming more frequent. So, for example, climate change is increasing the frequency of natural disasters. There is also geopolitical risks that have exposed a vulnerability of depending very heavily on just one country. So, for example, we had lockdowns in China. We had the Russian invasion of Ukraine. So, that has created new risks that we need to take into account going forward. So, the question is how can firms and how can governments internalize uncertainty of a future shock and what can they do today to hedge the risks of something happening in the future, and this is a very difficult thing to do. And, it's going to be very challenging, but I think we need to create more resilient supply chains and there is room for policy intervention either through trade policy or through industrial policy or both in order to prevent the supply shortages from happening when the next shock hits.

Hasenstab: That struck me when you said more resilient supply chain. Can you tell me a little bit more about that?

Santacreu: Right. So, there are different things that firms can do to create more resilient supply chains. So, one thing would be to diversify the number of suppliers that they have so they don't rely just on one supplier and they put the risk on what's happening with that supplier, and we do see that firms have been diversifying their supply chains, especially those firms that were exposed to countries that experienced stronger lockdowns diversify the number of suppliers. Something that firms could do as well is to, instead of diversify the number of suppliers around the world, just create allies and regionalize their supply chain so that they just source their inputs from a few countries that are located close by. And, the other thing that firms could do is to increase the number of inventories that they have and think about what is the optimal level of inventories that they need to have so that when the next shock hits they can actually use whatever they have in their inventory.

Hasenstab: So, thinking ahead?

Santacreu: Thinking ahead, that's the most challenging part, but I think it's the most important thing to do right now to hedge the risks.

Hasenstab: Absolutely. You've given us a lot to think about today. To read more about Ana Maria's research and to hear her previous podcast episodes, visit stlouisfed.org. That's where you can also find all our Timely Topics podcast episodes where we feature conversations with research economists from the St. Louis Fed. You can also find Timely Topics on Apple Podcasts, Spotify, or wherever you like to listen to podcasts. Ana Maria, thank you so much for your time today.

Santacreu: Thank you.

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