Answer to Question #313164 in Macroeconomics for captain nyagah

Question

Following the oil price shocks of the 1970s, Keynesians concede that supply shocks can cause recessions, but it is not the main source of recessions. Discuss.

Answer 1

The role of policy credibility. In the case of the 1970s, the Federal Reserve's commitment to keeping inflation low was weak, so the oil price shocks shifted the aggregate supply curve upward not only due to the shock itself, but also due to higher inflation expectations as a result of weak Fed credibility. In contrast, the Federal Reserve's commitment to keep inflation low and stable in the last couple of decades has created strong Fed credibility. Similarly, inflation and unemployment as compared to the shock which affected the economy beginning in 1970s, actual inflation and the unemployment were more subdued than the other years.