Economic Shocks: Definition and Examples - SmartAsset (2023)

Economic Shocks: Definition and Examples - SmartAsset (1)

An economic shock, also known as a macroeconomic shock, is any unexpected event that has a large-scale, unexpected impact on the economy. Many, but not all, economists also say that a shock has to be “exogenous,” meaning that it comes from outside the economy instead of arising from developments within it. We’ll explain what is and isn’t considered an economic shock, the different types of economic shocks and some historical examples of economic shocks.

What Is an Economic Shock?

While there is not an absolute consensus among scholars about the definition of an economic shock, there are four features that commonly are understood to define an economic shock.

Singular or short-term event

An economic shock is a single or short-term event. By its nature, this event breeds instability because it results in either costs or gains that have not been priced into the market. Long-term trends aren’t considered economic shocks because the economy has time to adjust. For example, an industry disappearing overnight would be considered a shock, while an industry fading out over several decades would not.

Large-scale

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By large-scale, economists mean that the event has to affect the entire economy or close to it. Individual industries or geographic areas can suffer local or regional economic shocks, but the more local the event is the less likely it is to meet the definition. Events that affect only a certain group of people, such as those hit by the Bernie Madoff scandal, are more likely to be considered “financial shocks,” meaning an event which affects the personal finances of individuals rather than the economy at large.

Unexpected

An economic shock is an event that was neither planned nor foreseen. As a result, it causes unexpected changes to the economy.Anticipated events, such as demographic trends, are generally priced into the marketplace. Consumers, businesses and investors spend according to what they know is coming. Unanticipated events, by definition, are not. They catch the market by surprise and, as a result, have unpredictable consequences.

Exogenous

Many – but not all – economists argue that an economic shock must come from outside the economy, in other words, be exogenous. Something like weather, political upheaval or war would meet this definition.By this logic, however, an event like the 2008 financial crisis would not necessarily be considered an economic shock since the crisis arose from within the economy, namely, a series of financial decisions. This has led some economists to argue that an economic shock doesn’t need to be exogenous.

Types of Economic Shocks

Economic Shocks: Definition and Examples - SmartAsset (2)There are many types of economic shocks, all depending on what happens and how widespread its effects are. A few of the main forms to look for are:

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Macro

A macroeconomic shock is one that affects an economy at either a multinational or global scale. Given the highly interconnected nature of modern financial markets, a growing number of events can have macroeconomic impact. For example, any significant increase in the price of oil can create a macroeconomic shock on a global scale by increasing the price to transport, produce and use most products.

Supply Side

Supply-side economic shocks occur when it suddenly becomes significantly more expensive or difficult to produce goods and services in one or more sectors of the economy. Weather events are a classic supply-side economic shock. If a storm or other natural disaster cuts off access to raw materials, it gets much more difficult for a business to produce goods based on that product.

Demand

Demand-side economic shocks, which are among the most common types of economic shocks, occur when consumers change their spending patterns sharply and significantly. A weak job market is the classic demand-side economic shock. If an event causes massive layoffs or a downturn in the stock market, consumers may slash spending, triggering a negative feedback loop of businesses losing money, leading to more layoffs and a further cut in consumption.

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Downward or upward

Downward economic shocks are events that hurt the economy, causing lost value, slower production and layoffs. They are the chief cause of recessions, and as a result downward shocks get most of the attention. Upward economic shocks help the economy. These are unanticipated events that create value, boost productivity, create new jobs in new industries or otherwise help make the economy stronger in some significant way.

Examples of Economic Shocks

Economic Shocks: Definition and Examples - SmartAsset (3)Economic shocks can come from many different sectors. Some of the most common, however, are:

Weather and natural disasters

Weather and natural disasters can cause both downward and upward economic shocks. A drought in Australia followed by widespread bushfires in eastern Australia will cost the nation billions. One economist estimates the cost of recovery will be close to$100 billion.

Technology

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A technological shock comes from any area that relies on technology in some way. Often this includes energy production and prices or communications. However, a technology shock can also refer to new developments that meaningfully change productivity or industries. A new invention, if its impact is large enough, is considered an economic shock, either upward or downward depending on its actual impact. Henry Ford’s development of assembly line manufacturing, for example, is considered an upward economic shock.

Politics

A political economic shock comes from state or non-state actors and is sometimes based on politically motivated actions. Most often this comes from public policy. For example, a significant change to the Federal Reserve’s interest rate could cause a political economic shock, as this would affect the economy as a whole based on a policy decision. More disruptively, geopolitical events such as war and terrorism, or a trade war, are also considered political shocks, as they can cause economic chaos based on politically motivated acts.

The Bottom Line

An external shock is an unexpected event that dramatically changes an entire economy’s direction, either upward (value gains and job creation) or downward (value lost and job destruction). Depending on one’s views, the cause of an economic shock can also come from within an economy.

Tips for Responding to Shocks

  • A financial advisor can use smart diversification strategies to protect your portfolio from the risk of a downward economic shock. Finding the right financial advisor who fits your needs doesn’t have to be hard.SmartAsset’s free toolmatches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals,get started now.
  • A downward economic shock does not necessarily mean you should pull entirely out of the market. When things go south,you actually have a number of options. The same goes for market trends: securities moving in a consistent direction open specific opportunities.

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Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.

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FAQs

What are examples of economic shocks? ›

A stock market crash, a liquidity crisis in the banking system, unpredictable changes in monetary policy, or the rapid devaluation of a currency would be examples of financial shocks.

What is a shock in the economy? ›

A monetary policy shock occurs when a central bank changes, without sufficient advance warning, its pattern of interest rate or money supply control. A fiscal policy shock is an unexpected change of government spending or taxation amounts.

What are examples of external shocks? ›

Those external shocks include a real oil price shock, a trade shock, a financial shock, and a monetary shock.

What are some examples of positive external shocks? ›

Positive demand shocks have the effect of increasing aggregate demand in the economy, leading to increased consumption.
...
Examples of positive demand shocks include:
  • Interest rate cuts.
  • Tax cuts.
  • Stimulus checks.

Which of the following is an example of a demand shock? ›

Which of the following is an example of a demand shock? Consumers become worried about job loss and buy fewer goods and services than expected.

What are market shocks? ›

market shock. Definition English: A disruption of market equilibrium (that is, a market adjustment) caused by a change in a demand determinant (and a shift of the demand curve) or a change in a supply determinant (and a shift of the supply curve).

Is inflation a shock? ›

One positive supply shock that can have negative consequences for production is monetary inflation. A large increase in the supply of money creates immediate, real benefits for the individuals or institutions who receive the additional liquidity first; prices have not had time to adjust in the short run.

How does an economic shock affect unemployment? ›

Negative shocks decrease output and increase unemployment. Positive shocks increase production and reduce unemployment. The effect on inflation, however, will depend on whether the shock was a supply shock or a demand shock.

What causes a demand shock? ›

A demand shock is a large but transitory disruption of the market price for a product or service, caused by an unexpected event that changes the perception and demand. An earthquake, a terrorist event, a technological advance, and a government stimulus program can all cause a demand shock.

What are macro economic shocks? ›

An economic shock, also known as a macroeconomic shock, is any unexpected event that has a large-scale, unexpected impact on the economy. Many, but not all, economists also say that a shock has to be “exogenous,” meaning that it comes from outside the economy instead of arising from developments within it.

What is a macroeconomic shock quizlet? ›

Macroeconomic shock. An unexpected exogenous event that has a significant effect on an important sector of the economy or on the economy as a whole.

What are fiscal shocks? ›

We identify these shocks using news on spending in future quarters. We label changes to government spending that have not been anticipated but that are perceived as changes to fiscal spending upon their realisation as unexpected fiscal changes. We identify these shocks using news on spending in the current quarter.

Was COVID-19 a supply or demand shock? ›

The COVID-19 pandemic can be seen as both a supply shock and a demand shock.

Was the Great Recession a demand shock? ›

During the global financial crisis of 2008, a negative demand shock in the United States economy was caused by several factors that included falling house prices, the subprime mortgage crisis, and lost household wealth, which led to a drop in consumer spending.

Can supply shocks cause inflation? ›

Supply shocks cause relative price changes, not inflation.

Which of the following is an example of a positive demand shock? ›

If there is a large increase in funds allocated for defense, we will have increased spending, which is an example of a positive demand shock. Hence, the correct answer is the option a) a large increase in defense spending \textbf{a) a large increase in defense spending} a) a large increase in defense spending.

What is an example of a negative supply shock? ›

Negative Supply Shock

Causes the quantity supplied to be rapidly reduced, and the price to increase quickly until a new equilibrium is reached. A good example of this would be any natural disaster or other unanticipated event that disrupts the production process and/or supply-chain.

Which of the following will cause a positive demand shock? ›

Solution. Option A An increase in wealth will lead to a positive demand shock because people now have more income to spend.

How do macroeconomic shocks relate to the business cycle? ›

How do macroeconomic shocks relate to the business​ cycle? The business cycle results from the response of households and firms to macroeconomic shocks. do not fully adjust in the short run to changes in demand or​ supply, while in the long run they do fully adjust.

What are aggregate demand shocks? ›

Shocks to aggregate demand is anything that reduces money demand: the velocity of money. Policies that the Federal government can implement to move the aggregate demand back to its natural level is increasing/decreasing the velocity of money or “skillfully controlling the money supply” (Mankiw 287).

What is growth shock? ›

We find that a growth shock is inequality-increasing, and an inequality shock is growth-reducing. We also find, however, that the sizes of the effects of these shocks are very small, accounting for under 2 per cent of the variance for both countries.

What is positive monetary shock? ›

In the model, a positive shock increases the return on assets, making households forgo some consumption, which falls. The supply effect causes the cost of capital to rise, and therefore the value of capital and investment falls.

How do you deal with supply shocks? ›

Dealing with a supply-side shock
  1. Raise interest rates to reduce inflationary pressure.
  2. Cut interest rates to boost economic growth.
12 Nov 2019

What are monetary policy shocks? ›

We estimate monetary policy shocks as the residuals from a prediction of changes in the federal funds rate using (i) numerical forecasts in the documents that Fed economists prepare for the FOMC, (ii) the verbal information in the documents, and (iii) nonlinearities in (i) and (ii).

How did Covid disrupt the economy? ›

The COVID-19 pandemic and resulting economic fallout caused significant hardship. In the early months of the crisis, tens of millions of people lost their jobs. While employment began to rebound within a few months, unemployment remained high throughout 2020.

How does a negative supply shock affect inflation? ›

This negative real shock would cause the LRAS to shift to the left, which causes not only a decrease in GDP, but an increase in inflation. These two issues (recession and high inflation) typically require opposite policies from the Fed.

How did Covid affect the global economy? ›

The toll the COVID-19 pandemic has exacted on the global economy has been significant, with the International Monetary Fund (IMF) estimating that median global GDP dropped by 3.9% from 2019 to 2020, making it the worst economic downturn since the Great Depression.

Which of the following will cause a negative demand shock? ›

Increase in taxes and reduction in government spending both result in negative demand shocks, shifting the aggregate demand curve to the left.

What are supply-side shocks? ›

A sudden, unexpected and significant change in the cost of a factor of production, such as changes in wage rate, commodity prices or taxes, that causes a shift in the aggregate supply curve.

What is a negative real shock? ›

Monetary Policy: The Negative Real Shock Dilemma - YouTube

How do you distinguish a demand shock from a supply shock? ›

Lockdown measures preventing workers from doing their jobs can be seen as a supply shock. A demand shock, on the other hand, reduces consumers' ability or willingness to purchase goods and services, at given prices. People avoiding restaurants for fear of contagion is an example of a demand shock.

Which of the following is usually the cause of stagflation? ›

Causes of stagflation

Oil price rise Stagflation is often caused by a supply-side shock. For example, rising commodity prices, such as oil prices, will cause a rise in business costs (transport more expensive) and short-run aggregate supply will shift to the left. This causes a higher inflation rate and lower GDP.

Which of the following is usually the cause of stagflation quizlet? ›

Which of the following is usually the cause of​ stagflation? there will be a movement up along a stationary aggregate demand curve.

When the economy experiences stagflation which of the following occurs? ›

Stagflation occurs when an economy experiences slow economic growth (stagnation) and high unemployment alongside high levels of inflation (rising prices for goods and services).

What are the leading indicators of economic change? ›

Top Five Leading Indicators. There are five leading indicators that are the most useful to follow. They are the yield curve, durable goods orders, the stock market, manufacturing orders, and building permits.

What is fiscal policy economics? ›

Fiscal policy is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty.

What is the difference between financial investment and economic investment? ›

Investments in economics can either be financial or economic. Financial investments pertain to the purchase of financial products like bonds, whereas economic investments relate to buying business capital like new machinery.

What is a good example of supply and demand? ›

A company sets the price of its product at $10.00. No one wants the product, so the price is lowered to $9.00. Demand for the product increases at the new lower price point and the company begins to make money and a profit.

What is Keynesian supply shock? ›

A Keynesian supply shock is more likely when the elasticity of substitution between sectors is relatively low, the intertemporal elasticity of substitution is relatively high, and markets are incomplete.

How does demand and supply affect the economy? ›

It's a fundamental economic principle that when supply exceeds demand for a good or service, prices fall. When demand exceeds supply, prices tend to rise. There is an inverse relationship between the supply and prices of goods and services when demand is unchanged.

When was the last economic crash? ›

In the Great Depression, GDP fell by 27% (the deepest after demobilization is the recession beginning in December 2007, during which GDP has fallen 5.1% as of the second quarter of 2009) and unemployment rate reached 10% (the highest since was the 10.8% rate reached during the 1981–1982 recession).

What caused economic crash of 2008? ›

What Caused the 2008 Financial Crisis? The 2008 financial crisis began with cheap credit and lax lending standards that fueled a housing bubble. When the bubble burst, the banks were left holding trillions of dollars of worthless investments in subprime mortgages.

Was 2008 worse than the Great Depression? ›

Ten years ago, we were hit by the biggest financial shock in world history, worse even than the Great Depression. Indeed, during the 1930s, “only” a third of U.S. banks failed, while in 2008, former Federal Reserve chairman Ben S.

What is an example of a supply shock? ›

In the context of history, supply shocks have been caused by things like weather, war and labor strikes. For example, the 1973-74 oil embargo, in which OPEC members retaliated against the U.S. and other nations for supporting Israel, caused gas shortages and long lines at the pump.

What is one of the most famous supply shocks in American history? ›

The dramatic rise in inflation between 1972 and 1974 can be attributed to three major supply shocks—rising food prices, rising energy prices, and the end of the Nixon wage-price controls program—each of which can be conceptualized as requiring rapid adjustments of some relative prices.

Can monetary policy fix supply shocks? ›

This is an adverse supply shock, which shifts the aggregate supply curve to the left. However, it does not directly cause a decrease in aggregate demand, or a decrease in nominal GDP. Instead, prices will rise and real GDP will fall. Monetary policy cannot fix that problem.

Is inflation a shock? ›

One positive supply shock that can have negative consequences for production is monetary inflation. A large increase in the supply of money creates immediate, real benefits for the individuals or institutions who receive the additional liquidity first; prices have not had time to adjust in the short run.

What is a macroeconomic shock quizlet? ›

Macroeconomic shock. An unexpected exogenous event that has a significant effect on an important sector of the economy or on the economy as a whole.

What are monetary policy shocks? ›

We estimate monetary policy shocks as the residuals from a prediction of changes in the federal funds rate using (i) numerical forecasts in the documents that Fed economists prepare for the FOMC, (ii) the verbal information in the documents, and (iii) nonlinearities in (i) and (ii).

What are fiscal shocks? ›

We identify these shocks using news on spending in future quarters. We label changes to government spending that have not been anticipated but that are perceived as changes to fiscal spending upon their realisation as unexpected fiscal changes. We identify these shocks using news on spending in the current quarter.

What causes a supply shock? ›

Supply shocks are caused by unforeseen events that reduce output or interrupt the supply chain, such as natural disasters or geopolitical events. Crude oil is a commodity that is considered vulnerable to negative supply shocks due to the political and social volatility of its Middle East source.

What is a positive demand shock? ›

A demand shock is a sudden unexpected event that dramatically increases or decreases demand for a product or service, usually temporarily. A positive demand shock is a sudden increase in demand, while a negative demand shock is a decrease in demand.

What is growth shock? ›

We find that a growth shock is inequality-increasing, and an inequality shock is growth-reducing. We also find, however, that the sizes of the effects of these shocks are very small, accounting for under 2 per cent of the variance for both countries.

How do macroeconomic shocks relate to the business cycle? ›

How do macroeconomic shocks relate to the business​ cycle? The business cycle results from the response of households and firms to macroeconomic shocks. do not fully adjust in the short run to changes in demand or​ supply, while in the long run they do fully adjust.

Which of the following is usually the cause of stagflation? ›

Causes of stagflation

Oil price rise Stagflation is often caused by a supply-side shock. For example, rising commodity prices, such as oil prices, will cause a rise in business costs (transport more expensive) and short-run aggregate supply will shift to the left. This causes a higher inflation rate and lower GDP.

Which of the following is usually the cause of stagflation quizlet? ›

Which of the following is usually the cause of​ stagflation? there will be a movement up along a stationary aggregate demand curve.

How do you identify monetary policy shocks? ›

We identify monetary policy shocks by exploiting variation in the central bank's information set. To be specific, we use differences between nowcasts of the output gap and inflation with final, revised estimates of these series to isolate movements in the policy rate unrelated to economic conditions.

What are the example of monetary policy? ›

Monetary policy refers to the steps taken by a country's central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.

What does monetary policy mean in economics? ›

Monetary policy refers to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. Fiscal policy refers to the tax and spending policies of the federal government.

What impact will a negative demand shock have on the main measures of economic performance? ›

Negative shocks decrease output and increase unemployment. Positive shocks increase production and reduce unemployment. The effect on inflation, however, will depend on whether the shock was a supply shock or a demand shock.

What are the leading indicators of economic change? ›

Top Five Leading Indicators. There are five leading indicators that are the most useful to follow. They are the yield curve, durable goods orders, the stock market, manufacturing orders, and building permits.

What is shock therapy Russia? ›

Shock therapy is an economic program intended to transition a planned economy or developmentalist economy to a free market economy through sudden and dramatic neoliberal reform.

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