What is an 'Economic Shock'

An economic shock is an event that occurs outside of an economy, and produces a significant change within an economy.

BREAKING DOWN 'Economic Shock'

Economic shocks are events that impact an economy while occurring outside of it, and are not answerable through economics. They are unexpected and unpredictable and typically dramatically impact supply or demand throughout the markets.

Different Kinds of Economic Shocks

Economic shocks may come in a variety of forms.

A shock due to constrained supply is a supply shock. A shock in the supply of staple commodities, such as oil, can cause prices to skyrocket, making it expensive to use for business purposes. These can be produced, often, by accidents and disasters.

The rapid devaluation of a currency would produce a shock for the import/export industry because a nation would have difficulty bringing in foreign products.

A technology shock results from technological developments that affect productivity.

Inflationary shocks occur when the prices of commodities go up (either due to a supply shock, or a decrease in subsidies), and the increase in commodity prices is not followed immediately by a societal salary adjustment. This can lead to a loss of purchasing power. This can happen on larger scales, too, as the cost of production falls behind corporate revenues, largely for the same reason. 

Demand shocks happen when there is a sudden and considerable shift in the patterns of private spending, either in the form of consumption spending from consumers, or investment spending from businesses. 

Monetary policy shocks occur when a central bank departs, without proper advance warning, from an established pattern of interest rate increase or decrease, or money supply control. 

A fiscal policy shock is an unexpected change in government spending or tax levels. 

These are all macroeconomic shocks, but we also see shocks at the microeconomic level, in households, which can sometimes be the manifestation of macroeconomic trends in more specific contexts. These can include health, income, consumption and taxation shocks. 

It's worth noting that changes can be positive or negative, too. 

Impulse Response Functions 

Impulse response is a term used widely, but in economics, it's used to refer to contemporary macroeconomic modeling, and are used to describe how the economy reacts over time to economic shocks from exogenous factors described above. It is used to measure the reaction of endogenous economic factors—factors within the economy—like output, consumption, investment and employment, at the time of shock and at a number of times thereafter. 

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