demand-side shock

Sometimes the whole economy's willingness to spend lurches suddenly — for reasons that have nothing to do with how much it can produce. A stock-market crash wipes out wealth and frightens shoppers; a wave of optimism sets households and firms spending freely; a foreign recession dries up demand for a country's exports. Any sudden, economy-wide jolt to total spending is a demand-side shock. The factories and workers are unchanged; what jumps or collapses is the appetite to buy.

In the AD-AS model, a demand shock shifts the aggregate demand curve. A negative demand shock pushes AD left: in the short run both output and the price level fall, so you get a recession with falling or low inflation — output and prices move the same direction. A positive demand shock pushes AD right: output rises and prices rise too, an overheating boom. The telltale signature of a demand shock is that output and inflation move together — both up in a boom, both down in a slump. That is the clue that distinguishes it from a supply shock, where they move in opposite directions.

Demand shocks are at the heart of ordinary recessions and booms, and they are the kind of shock policy can most readily counter: if private spending collapses, the government or central bank can try to fill the hole by boosting spending or cutting interest rates. The honest nuance is that diagnosing a shock as 'demand' versus 'supply' in real time is hard, and many real events are both at once — a pandemic, for instance, slashed demand for travel while also disrupting the supply of goods.