672 PA R T V I I Monetary Theory Suppose that there is a negative supply shock for example, an oil embargo that raises oil prices (or workers could have successfully pushed up their wages) As displayed in Figure 26-4, the negative supply shock shifts the short-run aggregate supply curve from AS1 to AS2 If the money supply remains unchanged, leaving the aggregate demand curve at AD1, we move to point 1*, where output Y1* is below the natural rate level and the price level P1* is higher The short-run aggregate supply curve will now shift back to AS1 because unemployment is above the natural rate, and the economy slides down AD1 from point 1* to point The net result of the supply shock is that we return to full employment at the initial price level, and there is no continuing inflation Additional negative supply shocks that again shift the short-run aggregate supply curve leftward will lead to the same outcome The price level will rise temporarily, but persistent inflation will not result The conclusion that we have reached is the following: supply-side phenomena cannot be the source of persistent high inflation.3 Summary Our aggregate demand and supply analysis shows that persistent high inflation can occur only with a high rate of money growth As long as we recognize that inflation refers to a continuing increase in the price level at a rapid rate, we now see why Milton Friedman was correct when he said that inflation is always and everywhere a monetary phenomenon LRAS Aggregate Price Level, P AS2 AS1 P1* 1* P1 AD1 Y1* FIGURE 26-4 Yn Aggregate Output, Y Response to a Supply Shock A negative supply shock (or a wage push) shifts the short-run aggregate supply curve leftward to AS2 and results in high unemployment at point 1* As a result, the short-run aggregate supply curve shifts back to the right to AS1, and the economy returns to point 1, where the price level has returned to P1 Supply-side phenomena that alter the natural rate level of output (and shift the long-run aggregate supply curve at Yn ) can produce a permanent one-shot change in the price level However, this resulting one-shot change results in only temporary inflation, not a continuing rise in the price level