The Role of Production Networks in Price Stability

The pandemic inflation, the war in Ukraine, and now a potential energy crisis from the war in Iran, have all sparked interest in the relationship between inflation and sector-specific price shocks. In a now foundational work, Weber et. al (2024a) put forward a “production networks perspective” that uses input-output models to simulate how these sector-specific price shocks can drive increases in the general price level. Their results identified 8 sectors with systemically significant prices that disproportionately drive inflation in the U.S economy. This paper extends that analysis by disaggregating the results of price shocks to systemically significant sectors and demonstrates how their inflationary outcomes are themselves composed of shifting relative prices. By extension, consumer price indexes are argued to be a poor metric for assessing inflation that results from sectoral shocks. This extension is motivated by a conceptualization of inflation not as a movement in the price level but instead a shift in the price system encompassing all stages of the production process that create the cost structure for consumer prices. The results suggest that analyzing inflation as a disaggregated process has two main benefits: (1) it allows for the identification of the specific transmission mechanisms for price shocks and shows which pathways through production networks are the most inflationary, and (2) identifying these pathways refines the classification of systemically significant prices by showing which sectors are more likely to originate price shocks while other amplify them. I conclude by arguing that price stability can be best achieved by building structural resilience in these production networks through policies that implement strategic commodity buffer stocks and facilitate the transition away from fossil fuels.