Key findings
- This Note decomposes retail trade inflation into supply- and demand-driven components using the methodology of Shapiro (2024). I find that, on average, the proportion of supply-driven contributions to inflation is higher than demand-driven contributions over the history of the series.
- At the onset of COVID-19 in 2020, contributions of demand-side factors were initially much larger than those of supply-side factors. However, since late 2022, supply-side factors have contributed a far greater proportion of year-on-year headline retail trade inflation.
- Though the results are based on retail trade inflation, similar insights emerge from decomposing household consumption expenditure inflation. The results are also in line with findings in the international literature based on other inflation measures.
Why we did this research
Recent periods of supply-side pressures have re-emphasised the importance of understanding what factors are influencing the economy, particularly in the context of monetary policy decisions. Demand-driven inflation can be combatted effectively by monetary policy as domestic output and inflation measures respond in complementary ways when aggregate demand is targeted. In contrast, a supply-driven surge in inflation introduces trade-offs for monetary policy between stabilising output and inflation. Understanding what is driving inflation is pivotal to determining the correct policy stance.
This Note decomposes New Zealand’s retail trade inflation into supply and demand drivers through the lens of the model of Shapiro (2024). The model uses the intuitive approach of labelling price movements in category-level data as either supply or demand driven based on the signs of unexpected movements in prices and quantities.
The research presented in this Note is aligned with our monetary policy research agenda themes — inflation, small open economy macroeconomics.
What data have we used?
The New Zealand application of the methodology of Shapiro (2024) uses quarterly retail trade sales turnover and sales volume data from 1995Q3 to 2023Q4 on a seasonally adjusted basis. This data is split into the following 15 similarly grouped categories:
| Retail trade categories |
|---|
| Pharmaceutical and other store-based retailing |
| Department stores |
| Accommodation |
| Specialised food retailing |
| Furniture, floor coverings, houseware, and textile goods |
| Liquor retailing |
| Electrical and electronic goods retailing |
| Non-store and commission-based retailing |
| Fuel retailing |
| Supermarket and grocery stores |
| Recreational goods retailing |
| Clothing, footwear, and personal accessories |
| Hardware, building, and garden supplies |
| Food and beverage services |