Supply shock
Topic: Inflation and Index Numbers: CPI, WPI, IIP and the Deflator · NCERT: Beyond NCERT
Meaning
A supply shock is a sudden change in the supply of a key input such as oil, food or fertiliser. An adverse shock shifts aggregate supply to the left, meaning less can be produced at every price. Prices rise and output falls at the same time. That is why big supply shocks can cause stagflation, which is high inflation together with stagnant growth. Monetary policy has limited power against such shocks because they do not come from excess demand.
Example
Two examples:
- The 1973 oil embargo.
- The 2022 Russia–Ukraine war, which pushed up the prices of oil, gas, fertiliser, edible oil and wheat. In 2022, India's WPI inflation reached double digits.
In India, a monsoon failure or a heatwave works as a food supply shock.
Don't confuse with
- Demand-pull inflation: prices rise because demand runs ahead of supply, and output usually rises too. In an adverse supply shock, output falls.
- Structural inflation: this comes from long-lasting bottlenecks, not a sudden event.
Related concepts
- Demand-pull inflation
- Output gap
- Cost-push inflation
- Imported inflation
- Wage-price spiral
- Greedflation
- Structural inflation
- Inflation expectations
- Anchoring of inflation expectations