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Supply Shocks and Monetary Policy Revisited

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  • Robert J. Gordon

Abstract

This paper reviews the main issues that supply shocks pose for the conduct of monetary policy. A simple version of the Gordon-Phelps model shows that the necessary condition for actual real GNP to be maintained at its equilibrium level in the wake of a supply shock is for the change innominal GNP to exceed the change in the nominal wage by the change in the income share of the raw material in GNP. The required "wedge" between nominal GNP and wage growth can be accomplished by any combination of monetary accommodation and nominal wage flexibility. Without this combination a "macroeconomic externality" occurs, with real CNP falling below its equilibrium level. The obstacles to monetary accommodation are examined in terms of a taxonomic wage adjustment equation that allows for differing responses to current inflation, lagged inflation, and lagged wage change. Monetary accommodation is infeasible when there is full indexation to current inflation and creates a permanent acceleration of inflation following a one-time permanent shock when there is indexation to lagged inflation. With "forward-looking" expectation formation in the sense of Taylor, a supply shock is likely to cause changes in parameters of the wage adjustment equation as workers attempt to avoid the macroeconomic externality. The final section of the paper discusses doctrinal debates that originated in part from the empirical failures of earlier Phillips curves that neglected supply shocks.

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  • Robert J. Gordon, 1984. "Supply Shocks and Monetary Policy Revisited," NBER Working Papers 1301, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:1301
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    Cited by:

    1. Turnovsky, Stephen J, 1987. "Supply Shocks and Optimal Monetary Policy," Oxford Economic Papers, Oxford University Press, vol. 39(1), pages 20-37, March.
    2. Aurélien Goutsmedt, 2016. "The New Classical Explanation of the Stagflation: A Psychological Way of Thinking," Documents de travail du Centre d'Economie de la Sorbonne 16018, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    3. Toptancı, Ali İskan, 2021. "The Effects of Oil Price Shock on the World Economy: A Macroeconomic Analysis," EconStor Research Reports 231406, ZBW - Leibniz Information Centre for Economics.
    4. Robert J. Gordon, 2011. "The History of the Phillips Curve: Consensus and Bifurcation," Economica, London School of Economics and Political Science, vol. 78(309), pages 10-50, January.
    5. Reicher Christopher Phillip & Utlaut Johannes Friederich, 2013. "Monetary policy shocks and real commodity prices," The B.E. Journal of Macroeconomics, De Gruyter, vol. 13(1), pages 715-749, October.
    6. Robert B. Barsky & Lutz Kilian, 2004. "Oil and the Macroeconomy Since the 1970s," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 115-134, Fall.
    7. Freedman, Charles, 1990. "La politique monétaire des années 90 : leçons et enjeux," L'Actualité Economique, Société Canadienne de Science Economique, vol. 66(2), pages 147-186, juin.
    8. Robert Barsky & Lutz Kilian, 2000. "A Monetary Explanation of the Great Stagflation of the 1970s," NBER Working Papers 7547, National Bureau of Economic Research, Inc.
    9. Piero Bini, 2013. "The Italian Economists and the Crisis of the Nineteenseventies. The Rise and Fall of the "Conflict Paradigm"," HISTORY OF ECONOMIC THOUGHT AND POLICY, FrancoAngeli Editore, vol. 2013(1), pages 73-101.
    10. Mutascu, Mihai, 2019. "Phillips curve in US: New insights in time and frequency," Research in Economics, Elsevier, vol. 73(1), pages 85-96.
    11. Bennett T. McCallum, 1984. "Credibility and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 105-135.
    12. Lorde, Troy & Jackman, Mahalia & Thomas, Chrystol, 2009. "The macroeconomic effects of oil price fluctuations on a small open oil-producing country: The case of Trinidad and Tobago," Energy Policy, Elsevier, vol. 37(7), pages 2708-2716, July.
    13. Rotemberg, Julio J & Woodford, Michael, 1996. "Imperfect Competition and the Effects of Energy Price Increases on Economic Activity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 550-577, November.
    14. Ghanem Darine, 2012. "Fixed Exchange Rate Regimes and Inflation Performance: Evidence from MENA Countries," Review of Middle East Economics and Finance, De Gruyter, vol. 8(1), pages 1-30, August.
    15. Timothy J. Considine, 1988. "Oil Price Volatility And U.S. Macroeconomic Performance," Contemporary Economic Policy, Western Economic Association International, vol. 6(3), pages 83-96, July.
    16. Priyanshi Gupta & Anurag Goyal, 2015. "Impact of oil price fluctuations on Indian economy," OPEC Energy Review, Organization of the Petroleum Exporting Countries, vol. 39(2), pages 141-161, June.

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