During the 1970s, the world economy was hit with a series of unfavorable supply shocks that raised prices and lowered output, including spikes in oil prices and the prices of many agricultural commodities due to hurricanes, droughts, and floods that destroyed crops or land. As we have discussed, increases in oil prices shift the aggregate supply curve. However, they also have an adverse effect on aggregate demand. Because the United States is a net importer of foreign oil, an increase in oil prices is just like a tax that decreases the income of consumers. As we have seen, an increase in taxes will shift the aggregate demand curve to the left.
However, in the 1990s, things were different pleasantly different. Between 1997 and 1998, the price of oil on the world market fell from $22 a barrel to less than $13 a barrel. The result was that gasoline prices, adjusted for inflation, were lower than they had been in over 50 years. This not only meant cheaper vacations and commuting and an increase in SUV purchases, it also had positive macroeconomic effects. Favorable supply shocks allowed output to rise and prices to fall simultaneously the best of all worlds. In 2008, oil prices shot up to $145 a barrel, largely because of increased demand throughout the world, particularly in fast-growing countries such as China and India. Gasoline prices in the United States exceeded $4.00 a gallon. The economy had been weak prior to these increases, and policymakers feared the negative effects this major supply disturbance would have both on inflation and GDP. Indeed, although the price of gasoline fell in 2009 and 2010, the price increases in 2008 helped exacerbate the recession brought on by the difficulties experienced in the financial system.