# Supply Shock A **supply shock** is a sudden change in the economy's productive capacity or input costs (an oil embargo, a pandemic disruption, a war, a tariff) that moves prices without any corresponding change in demand. It is the case monetary policy handles worst, because the entire [[Monetary Policy Transmission Flow]] works on demand. ## The central bank's bind An adverse supply shock pushes inflation up and output down at the same time, so the two legs of the [[Dual Mandate]] point in opposite directions. Raising rates fights prices only by suppressing demand that was not causing the problem; the inflation target is reached by damaging employment. The alternative is to **"look through"** the shock: accept temporarily higher inflation on the theory that a one-time jump in the price level is not lasting inflation. That only works while [[Inflation Expectations]] stay anchored. Once people expect prices to keep rising, a one-time shock becomes an ongoing spiral, and the Fed must act after all. ## The record | Episode | Shock | What the Fed did, and what it taught | |---|---|---| | 1973–74 | OPEC oil embargo; oil prices roughly quadrupled | Accommodated it under [[Arthur Burns]]; inflation became entrenched, the [[Great Inflation]] | | 1979 | Iranian revolution, second oil shock | [[Paul Volcker]] chose to break expectations, at the cost of a deep recession | | 2021–23 | Pandemic supply chains, then Russia's invasion of Ukraine | Called it "transitory," then raised rates fastest since the 1980s; Bernanke and Blanchard's 2023 study found supply shocks drove most of the initial surge, with tight labor markets mattering more later | | 2025–26 | Tariffs; then the Iran war, the [[Strait of Hormuz]] blockade and Red Sea attacks ([[Bab el-Mandeb]]) | Diesel near record highs; the July 2026 FOMC statement blamed elevated inflation partly on supply shocks including energy | The lesson of the 1970s is that "looking through" fails when it is tried for too long. The lesson of 2021 is that waiting too long to decide costs credibility. ## Tariffs are the version now live Tariffs raise import prices directly. Unlike an embargo or a pandemic, they are policy rather than accident and can be sustained indefinitely, which makes the "temporary" framing harder to defend. They also put the Fed in a political trap. If it looks through tariff inflation, it risks the 1970s. If it fights it, it is seen as offsetting the president's trade policy with higher rates, inviting the pressure tracked in [[Central Bank Independence]]. ## See also - [[Monetary Policy Transmission Flow]] · [[Dual Mandate]] · [[Phillips Curve]] · [[Stagflation]] - [[Inflation Expectations]] · [[Great Inflation]] · [[Tariffs]] · [[Gas Prices]]