I recall in math the function of several variables,
where a variable is dependent on some other variables. In the case of macroeconomics, Quantity demanded
is a function of the price of the good demanded the price of related goods (substitutes)
or complementary goods.
Economic shocks are unpredictable and have an impact
on Supply or demand throughout the markets. We recall what happened to the
emerging markets a month ago, with currencies being devalued, and thus have a
impact on imports and exports. A shock
in the supply of commodities, like oil, can cause prices to skyrocket
If there is a surplus or shortage say in coffee,
consumers will switch to its substitute, tea. If we think of the Supply and
Demand curve, then any changes in one good will shift the equilibrium and the
demand curve of that good. Any shock will inevitably create a shift in the
demand curve, will create a shortage and thus lead to an increase in prices.
If personal income increases let us say, then
consumers will demand more of a good at each price, and the demand curve shifts
to the right. An increased demand will create a shortage, and thus an increase
in prices.
Two complementary goods are cars and gasoline. If the
price of gasoline rises, consumers will drive less, and car sales will decrease.
In one paper by the Federal Reserve of Dallas on “Large Global Volatility Shocks, Equity markets and Globalization”, they
define shocks, with respect to the US equity markets, as “months when unanticipated volatility in
the stock market was exceptionally high”.
In another very interesting paper I found, “Monetary shocks and Bond Market
Reactions”, December 1, 2008, on the
effect of monetary policy on bond yields, it states that exogenous shocks have
a stronger impact on bond yields than an endogenous policy action does. I
assume that they are implying the FED’s policy instruments, like open market
operations, or increasing the money supply.
In another paper by the IMF, on “Measuring Oil Price shocks using Market
based Information”, January 2011, they studied the effects of oil price shocks
in the US economy since 1984. The paper suggests that there is no compelling
evidence that after a positive oil price shock, GDP declines, and prices
increase. Their data was based on spot prices. Spot Price is the price at any
given moment in the market.
Their findings suggest that the US market has become less volatile and more
insulated from external shocks, due to a smaller degree of energy dependence. Data
was collected from oil trade journals, such as Oil Daily, and Oil and Gas
Journal. Their data run from January 3, 1984 to October 31, 2007.
The responses of market information on exogenous Oil price shocks, were on
GDP, the Federal Funds Rate (the rate at which the FED charges banks on
overnight borrowing), the Consumer Price Index, and the real price of oil. So
it is obvious, and the study found, that as a result of a positive oil price
shock, real GDP declines, and the prices increase.
Another important and interesting factor the paper is pointing out is the
effects of OPEC and Non OPEC oil price shocks. Although they are endogenous
(internal), as the paper points out, this has to do with decisions of oil
production output, and its impact on the global oil market. The implications
are that real GDP declines and CPI rises.
In the last part of this very interesting paper, they examine the impact of
military actions in the Middle East. The effects of oil price shocks tend to
drive up prices of oil, and thus have an impact on production and output.
