THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 667

CHAPTER 24

Aggregate Demand and Supply Analysis

635

The 1978 1980 period was almost an exact replay of the 1973 1975 period. By
1978, the economy had just about fully recovered from the 1973 1974 supply
shocks when poor harvests and a doubling of oil prices (as a result of the overthrow of the shah of Iran) again led to another sharp leftward shift of the aggregate supply curve. The pattern predicted by Figure 24-7 played itself out
again inflation and unemployment both shot upward (see Table 24-4).

The Perfect
Storm of
2007 2008:
Negative
Supply
Shocks in
Canada and
the Financial
Crisis

TA B L E 2 4 - 5

Higher demand for oil from rapidly growing developing countries like China and
India and the slowing of production in places like Mexico, Russia, and Nigeria
drove up oil prices sharply from around the US$60 per barrel level at the beginning of 2007. By the end of the year, oil prices had risen to US$100 per barrel and
reached a peak of over US$140 in July of 2008. The run up of oil prices along with
other commodity prices caused the aggregate supply curve to shift sharply leftward. As the aggregate demand and supply diagram in Figure 24-7 indicates, the
result was a rise in both unemployment and inflation.
If this supply shock were not bad enough, the subprime financial crisis hit the
economy in August of 2007, and reached a more virulent phase in the fall of 2008.

As discussed in Chapter 9, the financial crisis caused a contraction in both household and business spending, leading to a drop in aggregate demand and a shift of
the aggregate demand curve to the left, the exact opposite of the situation depicted
in Figure 24-6. Aggregate demand and supply analysis indicates that this would
lead to a rise in unemployment, with some weakening of inflationary pressure. As
our aggregate demand and supply analysis predicts, and as Table 24-5 shows, the
result of this perfect storm of negative shocks was a rise in unemployment from
the 6% level in the third quarter of 2007 to 6.1% in the third quarter of 2008 and
to 8.4% in the second quarter of 2009. Also, as the aggregate demand and supply
analysis predicts, inflation accelerated from 2.6% in the third quarter of 2007 to
5.8% in the third quarter of 2008, but with the increase in the unemployment rate
and the decline of oil and other commodity prices by the fall of 2008, inflation
began to fall back down again to 0.1% in the second quarter of 2009.

Unemployment and Inflation During the Perfect Storm of
2007 2008

Unemployment Rate (%)

Inflation Rate, Based on the
Chain Price Index for GDP (%)

2007, Q3

6.0

2.6

2008, Q3

6.1

5.8

2009, Q2

8.4

0.1

Year

Source: Bank of Canada s website.