Oil Prices Gas prices Industrial metals Food prices Commodity Prices FT.com • Commodities News and Market Data Share prices Credit crunch Financial Markets The decline in the dollar / rise of the Euro Exchange rates Sterling's depreciation against the Euro / rise against the US dollar Housing recession of the early 1990s Housing boom 1996•2007 Property Prices UK housing slowdown 2007• Sub•prime crisis in the United States Africa The $3 trillion war Wars and Terrorism Iraq War on Terror Katrina and New Orleans (2005) Floods Kobe (Japan) Earthquakes Natural Disasters Australia's drought 2008 Drought China 2008 Famine Interest rates Taxation Economic Policy Shocks Changes in tariffs and other trade barriers Trade policies Trade agreements e.g. NAFTA and the Enlargement of the EU Labour market policies (inc migration) AD+C+I+G+X•M Shocks affect one or more components of AD i. Fall in income and employment and a contraction of SRAS ii. Fall in consumer / business confidence iii. Negative multiplier effects Deflationary shocks • reduce AD iv. Negative accelerator effects (fall in C leads to fall in I) v. Possibility of negative output gap Demand•side Shocks vi. Possibly due to a recession / slowdown in economy of a close trading partner i. Adds to demand and output in economy ii. Often linked to strong growth in borrowing iii. Rising asset prices • positive wealth effect iv. Upward (demand•pull) pressure on prices Inflationary shocks • raise AD v. May cause a worsening of the trade balance vi. Pre•election tax cuts or spending spree vii. Economic boom in another country with strong trade links Demand and supply side shocks can happen at the same time 1. Raw material prices e.g. basic metals and foodstuffs 2. Wage costs SRAS • affected by changes in 3. Energy prices 4. Expected output and profits of producers Natural disasters • loss of natural, human 1. and physical capital 2. Movement of population LRAS • affected by changes in 3. Levels of capital investment spending a. Reduce supply at each price level (fall in SRAS) b. Create "cost•push" inflationary pressures Supply•side Shocks Global External c. Possible wage•price spiral effect Negative supply shocks "Economic Shocks" d. Fall in output and risk of stagflation e. Possible causes include higher energy prices and impact of drought and wars a. Increases supply at each price level (rise in SRAS) b. helps to keep inflation low Improvements in productivity Adoption and exploitation of new technology Positive supply shocks c. Associated with Falls in prices of important raw materials / components Increases in global supply of labour New producers entering domestic / global markets Depends on scope to change interest rates Floating exchange rates • depreciation might boost exports Changes in monetary policy Willingness of central bank to be 'pro•active' Effectiveness in controlling inflation expectations Using the 'automatic stabilisers of fiscal policy' Stabilisation policies can help to absorb the impact of external shocks Changes in fiscal policy Scope for changes in the budget deficit Stabilisation policies are designed Short term changes in direct and indirect taxes to moderate the impact of shocks Remember the time lags for different policies Higher government spending Economic Shocks Multiplier effects of different policies will vary and Macro Lower taxation Management Flexible real wages Flexibility of the labour market High mobility of labour Flexible employment contracts Flexible production Importance of the supply•side of the economy Ability to absorb cost changes Flexibility to switch markets Can domestic producers respond to a shock? Making demand less sensitive to changing prices Being innovative 1. The size of the shock e.g. the scale of a rise in oil prices in real terms 2. The duration of a shock – is a big price movement temporary or longer lasting? 3. How widespread is the shock on key industries in an economy 4. The size of resulting multiplier and accelerator effects 5. The ability of an economy to respond flexibly to unexpected events 6. Whether shocks might create systemic problems for an economy (e.g. wider contagion effects) Whether a demand side shock (e.g. a credit boom) causes a secondary supply•side effect 7. (e.g. higher wage inflation and a rise in expectations of inflation) Evaluation Points on The authorities may decide to interpret economic targets more flexibly e.g. the Fed Reserve cut interest "external shocks" 8. rates in 2008 despite signs of rising inflation High oil prices might stimulate investment in renewables Sharp fall in property prices will make housing more affordable Recession might cause a rise in saving and a re•balancing 9. Negative economic shocks can have some benefits of an economy after a financial boom Companies looking to reduce costs may accelerate improvements in productivity Low global inflation caused low interest rates and added to the financial bubble in the USA 10. Positive shocks can have some costs An economic boom brought about by a demand side shock might have damaging effects for the environment i. Exogenous shock ii. Output gap iii. Inflation expectations iv. Multiplier effect v. Accelerator effect vi. Profits vii. Confidence viii. Expectations Some Key Terms ix. Wealth effect x. Stagflation xi. Floating exchange rate xii. Inflation target xiii. Multiplier effect x iv. Counter•cyclical policies xv. Cyclical unemployment xvi. De•coupling Global_External_Economic_Shocks.mmap • 22/03/2008 •.