Constraints, Rigidity, and Risk in Global Supply Chains

Recent major shocks (e.g., US-China tariff increases and the COVID-19 pandemic) have reverberated through global supply chains. As a result, there is growing concern that dependence on foreign inputs exposes firms, and the macro-economy more broadly, to heightened risks. For example, supply chain disruptions have been widely blamed for the resurgence of inflation. Moreover, recent policy reforms have encouraged reshoring of manufacturing production. This project examines how key microeconomic features of input sourcing, including capacity constraints, sunk investments, and decision making under uncertainty, give rise to macroeconomic risks. The findings will enable policymakers to evaluate supply chain risks more accurately and design policies to manage those risks. In the first part of the project, the researchers will study how occasionally binding capacity constraints in the supply chain, and shocks to them, shape inflation. When domestic or foreign firms exhaust their capacity, they have an incentive to raise their price, by increasing the markup over marginal cost. In the aggregate, binding constraints shift domestic and import price Phillips Curves, like cost-push shocks in reduced form, and thus fuel inflation. Building this idea into a modern multisector, open economy, New Keynesian model, the project applies the framework to interpret recent US data and study optimal monetary policy responses to supply chain disruptions. In the second part of the project, the researchers investigate how firms invest in their supply chain capacity, and how those investments matter for the propagation of macroeconomic shocks. The project develops a framework in which firms undertake irreversible (sunk) investments to source inputs, which lock buyers into particular suppliers in the short run, who have limited supply capacity and are subject to shocks. It then explores how risk averse buyers invest in a portfolio of suppliers to manage risk. Further, it examines how those investments affect the propagation of shocks, and whether trade and industrial policies may correct inefficiencies in risk taking to mitigate aggregate volatility. The novelty of these projects lies in their synthesis of micro- and macro-perspectives on supply chain risks, as needed for policy analysis. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.