European Central Bank working paper finds production networks amplify inflation spillovers and persistence

The European Central Bank published a working paper finding that supply-chain linkages amplify the size and persistence of inflation following sectoral and macroeconomic shocks. The study uses a Bayesian vector autoregression covering 35 U.S. sectoral producer price indices and seven macroeconomic variables, with input-output data guiding long-run relationships. Its headline inflation forecasts are comparable to the Survey of Professional Forecasters and generally more accurate than those from a standard Bayesian vector autoregression using a Minnesota prior. Accounting for production networks produces larger and more persistent producer and consumer price responses to oil shocks, with peak sectoral effects increasing alongside oil intensity. It also gives narrowly focused cereal price shocks non-negligible aggregate inflation effects and shows that sectors with slower price adjustment can sustain inflation after the initial shock fades. A counterfactual exercise finds that fully offsetting an oil shock’s inflationary effect would require stronger monetary tightening and cause a larger, more persistent decline in industrial production.