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 - 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