An adverse supply side shock is an event that causes an unexpected increase in costs or disruption to production. This will cause the short run aggregate supply curve to shift to the left, leading to higher inflation and lower output.
Diagram showing supply side shock
SRAS shifting to the left causes a higher price level and lower real GDP.
Causes of adverse supply side shocks
- Rising oil prices e.g. cartel activity by OPEC restricting supply and pushing up prices.
- Bad weather – Hurricane Katrina disrupted supply in US.
- Declining productivity, e.g. general strikes
Cost push inflation
A consequence of a supply side shock is cost-push inflation. This causes higher inflation due to AS shifting to left.
More on cost-push inflation
Response to supply side shock
The difficulty of a supply side shock is that conventional monetary policy cannot deal with both higher inflation and lower real GDP at the same time.