Working Paper: NBER ID: w1119
Authors: Stanley Fischer
Abstract: The main issue discussed in the supply shock literature that followed the oil and food price shocks of the seventies was whether to accommodate. The supply shock reduces the equilibrium level of output, and monetary policy can not affect that. But in the seventies supply shocks were also followed by recessions. The question is whether monetary policy can and should be used to prevent such recessions. The paper analyzes the conditions underwhich a suppiy shock will result in recession, and the potential for monetary policy to offset the fall in output. The basic result is that a pure supply shock need not resultin a recession if the money stock is held constant.Aggregate demand effects associated with the supply shock--including the effectsof monetary policy attempts to fight the inflation caused by the supply shock--may cause a recession, as also may real wage resistance by workers. The choice of policy response to the supply shock then turns on the same basic issues as counter-cyclical policy in general, particularly the relative costs of inflation and unemployment.
Keywords: Supply Shocks; Wage Stickiness; Monetary Policy
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Supply Shocks (E39) | Output (Y10) |
| Passive Monetary Policy (E63) | Output (Y10) |
| Wage Stickiness (J31) | Unemployment (J64) |
| Monetary Policy Effects (E52) | Output (Y10) |
| Supply Shocks (E39) | Recession (E32) |
| Monetary Policy Response (E52) | Inflation (E31) |
| Supply Shocks (E39) | Aggregate Demand Effects (E00) |