An economic shock refers to any change to fundamental macroeconomic variables or relationships that has a substantial effect on macroeconomic outcomes and measures of economic performance, such as unemployment, consumption, and inflation. Shocks are often unpredictable and are usually the result of events thought to be beyond the scope of normal economic transactions.
Economic shocks have widespread and lasting effects on the economy and are considered significant factors triggering recessions and economic cycles.
Key Insights
- Economic shocks are random, unpredictable events that have a widespread impact on the economy and are born out of situations external to standard economic models.
- They can be differentiated based on whether they originate from supply or demand and categorized further by the economic sector they impact.
- Given the interconnected nature of markets, such shocks often cause a ripple effect with macroeconomic consequences, either beneficial or detrimental.
Diving Into the Nature of Economic Shocks
Economic shocks can be classified by their influence on either the supply or demand aspects of the economy. Additionally, they can be categorized by their origination from specific sectors within the economy. Finally, shocks can be distinguished as either real or nominal, depending on their roots in tangible economic activities or changes in the nominal values of monetary measures.
Due to the interlinked facets of markets and industries, substantial shocks in any sector can propagate through the economy, causing notable macroeconomic impacts. Economic shocks can be advantageous or detrimental, though most concerns typically revolve around their negative repercussions.
Exploring Different Types of Economic Shocks
Supply Shocks
A supply shock occurs when an event significantly disrupts production. This could be due to a spike in the costs of essential commodities like oil, making its usage prohibitively expensive for businesses.
Natural disasters such as hurricanes, floods, or earthquakes can initiate supply shocks, as can human activities like wars or terrorist incidents. Often, economists refer to supply-side disruptions as “technological shocks.”
Demand Shocks
Demand shocks involve a sudden and noticeable change in private spending habits, including consumer and business investments. For instance, an economic downturn in a principal export market can negatively affect business investments, particularly in export industries.
A drastic fall in stock or housing prices can trigger demand shocks as households reduce their consumption due to perceived loss of wealth. Economists often describe these purely demand-side disruptions as “non-technological shocks.”
Financial Shocks
A financial shock originates from the financial sector of the economy. Modern economies rely heavily on liquidity and credit to operate smoothly, meaning disruptions here can affect numerous industries simultaneously.
Examples include stock market crashes, banking liquidity crises, abrupt changes in monetary policy, or rapid currency devaluation. Financial shocks predominantly reflect nominal disturbances but carry significant real economic consequences.
Policy Shocks
These involve changes in government policy with substantial economic impacts, intentional or otherwise. For instance, fiscal policies aimed at adjusting aggregate demand through government spending deliberately comprise demand shocks.
However, impositions such as tariffs can simultaneously benefit local industries while negatively impacting local consumers. Sometimes, even the mere uncertainty or speculation about a policy change can induce economic shocks.
Technology Shocks
Technology shocks stem from technological innovations impacting productivity. The advent of computers and internet technology significantly boosted productivity across various occupations, constituting a positive technology shock.
The term “technology” in economic contexts often has broader implications. For instance, disruptions in energy prices are frequently categorized under technology shocks, but there is also a specific focus within the technology sector for such shocks.
Related Terms: macroeconomic variables, recessions, consume trends, fiscal policy, aggregate demand.
References
- The World Trade Organization. “Why Economic Resilience Matters”, Pages 41-42.
- Federal Reserve Bank of Dallas. “Why House Prices Surged as the COVID-19 Pandemic Took Hold”.
- Dieppe, Alistair, Francis, Neville, and Kindberg-Hanlon, Gene. “Technological and Non-Technological Drivers of Productivity Dynamics in Developed and Emerging Market Economies”. Journal of Economic Dynamics and Control, vol. 131, 2021, pp. 1.
