A positive demand shock increases aggregate demand (AD) and a negative demand shock decreases aggregate demand.Prices of goods and services are affected in both cases. When demand for goods or services increases, its price (or price levels) increases because of a shift in thedemand curve to the right. When demand decreases, its price decreases because of a shift in the demand curve to the left. Demand shocks can originate from changes in things such astax rates,money supply, andgovernment spending. For example, taxpayers owe the government lessmoney after a tax cut, thereby freeing up more money available for personal spending. When the taxpayers use the money to purchase goods and services, their prices go up.[1]
In the midst of a poor economic situation in theUnited Kingdom in November 2002, theBank of England'sdeputy governor,Mervyn King, warned that the domestic economy was sufficiently imbalanced that it ran the risk of causing a "large negative demand shock" in the near future. At theLondon School of Economics, he elaborated by saying, "Beneath the surface of overall stability in the UK economy lies a remarkable imbalance between a buoyant consumer and housing sector, on the one hand, and weak external demand on the other."[2]
During the2008 financial crisis and theGreat Recession, a negative demand shock in the United States economy was caused by several factors that included falling house prices, thesubprime mortgage crisis, and lost household wealth, which led to a drop inconsumer spending. To counter this negative demand shock, theFederal Reserve System loweredinterest rates.[3] Before the crisis occurred, the world's economy experienced a positive globalsupply shock. Immediately afterward, however, a positive global demand shock led to global overheating and rising inflationary pressures.[4]
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