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Supply Shocks: The Dilemma of Stagflation

J. Bradford DeLong
delong@econ.berkeley.edu
http://www.j-bradford-delong.net


A supply shock--a sudden increase in costs in an important part of the economy, like the 1973 tripling of world oil prices by the Organization of Petroleum Exporting Countries [OPEC] in the aftermath of the 1973 Arab-Israeli War--gives central bankers no good options.

The shock shifts the aggregate supply curve up and to the left. In response, central bankers can (a) expand demand to keep the shock from causing a recession, keeping production at potential output at the price of accelerating inflation; or (b) contract demand to keep the shock from adding to inflation, thus causing a deep recession.

In practice, central banks usually split the difference. This combination is called "stagflation."

Central Bank Credibility      


Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

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