Supply Shocks and Monetary Policy Revisited

Abstract

This paper reviews the main issues that supply shocks pose for the conduct of monetary policy.A simple version of the Gordon-Phelps model shows that the necessary condition for actual real GNP to be maintained at its equilibrium level in the wake of a supply shock is for the change in nominal GNP to exceed the change in the nominal wage by the change in the income share of the raw material in GP.The required 'wedge between nominal GNP and wage growth can be accomplished by any combina- tion of monetary accommodation and nominal wage flexibility.Without this combination a "macroeconomic externality" occurs, with real CNP falling below its equilibrju level.

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