David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 21 Aggregate supply, prices and adjustment to shocks
c
0
+: 1to *
a
;:
c
-
With aggregate supply AS0 and aggregatE
demand AD0, inflation is n6 and output is
Y6. For a given aggregate supply, a rise
in demand from AD0 to AD,, violates the
long-run inflation target at n;. Thus the
central bank raises i* to shift AD1 back
to AD0 and restore equilibrium at A.
Y6
Output
y
figure 21.6
A demand shock
Oil prices and UK inflation
The figure below shows the dramatic increase in oil prices after 2003. If oil price shocks lead to
inflation, why did so little inflation materialize? Was the Bank of England lulled into a false
sense of security? Should we be surprised that, by April 2007, the Bank had to justify why it had allowed UK
inflation to exceed the target range to which it is committed. Was it only the financial crash that spared the
Bank further embarrassment?
Oil price ($/barrel)
120.0 ----
100.0
80.0
60.0
40.0
20.0
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
UK CPI inflation (%)
-
P.'o P.