Effects of Economic Shocks

Discuss the effects of global economic shocks on both international and regional business cycles.

An economic shock is an event that produces a significant chance in economic within a country, despite it not strictly occurring in that region. These shock may have both positive or negative effects, this may vary between difference economies and on the different levels of integration between nations. An example of an economic shock is the recent Global Financial Crisis (GFC) that occurred in 2007-08 that began in the US, that later flowed onto the global economy, resulting in a global recession due to levels of integration being at a record high due to globalisation. These shocks also have different effects depending on regional and international situations, as the level of integration is usually higher between regions.

There are two types of external economic shocks that can be transmitted from the global economy to a domestic economy. Firstly, real shocks refer to changes in real variable such as world output, commodity prices or technological changes, these shocks can cause structural changes to occur. Due to globalisation and the increased integration between economies, this type of shock will likely affect the international trade flows and investment flows.

For example, during 2004-07, the global resource boom occurred, lifting world growth by 5% per annum. This increased demand for commodities such as iron ore, oil and gas originated from developing and emerging economies like China and India who were sustaining a high economic growth level of 8 to 10 percent. This boom had an immediate effect on exporting nations like Australia, Brazil and OPEC nations. This increased the aggregate supply of these economies through the rise of their terms of trade and also stimulated investment projects in resources as well as the additional infrastructure to combat this rise in demand.

The second type of external economic shock is financial or monetary shock. These are changes in financial variables such as global share prices, interest rates or inflation rates. This type of shock is transmitted more rapidly than real shocks, through and volatility and changes in assets prices. Effecting an economy’s international financial flows.

An example of this type of shock would be the withdrawal of capital from Asian economies in 1997, causing the Asian Currency Crisis. This lead to recessions in Asian which affected nations like South Korea, Thailand and the Philippines. The crisis started in Thailand with the withdrawal of investment causing their currency to collapse which forced the government to float the currency due lack of foreign currency to support its peg to the US dollar. As the crisis spread, most of south east Asian’s currency also collapsed.

External economic shocks can have both positive and negative effects