Cost-push shocks are inflationary impulses originating on the supply side — rising input costs, tariffs, wages, or energy prices — that lift the price level independent of demand. They worsen the output-inflation trade-off, forcing central banks to choose between accommodating higher prices or contracting activity.
How it works
In New Keynesian and DSGE frameworks, a cost-push shock enters the Phillips curve as an additive disturbance that raises inflation for a given level of the output gap — shifting the curve rather than moving along it. Because the model cannot directly observe frictions like tariffs, it absorbs them as this residual cost-push term, which is why it shows up in forecast downgrades.
Why it matters now
2025 US tariff policy is the canonical live cost-push shock: it raises import prices and producer costs without a corresponding demand surge, leaving the Fed with a stagflationary trade-off — tariffs both lift inflation and drag growth, which DSGE models register as a cost-push residual.
Example
After the 1973 OPEC embargo quadrupled oil prices, US CPI inflation jumped from roughly 6% to over 11% in 1974 while real GDP contracted — a textbook cost-push shock producing simultaneous inflation and recession (stagflation) that the demand-management tools of the era could not resolve.
Frequently asked
- What is a cost-push shock?
- A cost-push shock is a supply-side disturbance that raises the price level independent of demand — driven by higher input costs, wages, energy prices, or tariffs. It enters the Phillips curve as an additive term that lifts inflation for a given output gap
Glossary · output gap
The output gap is the percentage difference between an economy's actual output and its potential output — the level sustainable without generating inflationary pressure. A positive gap signals demand running hot; a negative gap signals slack. It is a central, if unobservable, input to monetary policy and Phillips-curve inflation forecasts.
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- How does a cost-push shock differ from a demand shock?
- A cost-push shock raises inflation while depressing output, whereas a demand shock pushes inflation and output in the same direction. This distinction matters for policy: a demand shock can be countered by tightening with no trade-off, but a cost-push shock forces central banks to choose between stabilising inflation and supporting growth.
- Why do cost-push shocks matter for monetary policy?
- Cost-push shocks create a stabilisation dilemma because they raise inflation and lower output simultaneously, breaking the 'divine coincidence' under which controlling inflation also stabilises activity. Central banks must weigh accommodating higher prices against contracting an already-weakening economy — the classic stagflation trade-off seen in the 1970s and again under tariff regimes.
- Are 2025 tariffs a cost-push shock?
- Yes — tariffs are a textbook cost-push shock because they raise import and producer prices without a matching rise in demand. In DSGE models, tariffs and similar unobservable supply frictions are absorbed as a cost-push residual, which is why tariff-driven inflation often appears in forecast downgrades rather than as a directly modelled variable.
- Did cost-push shocks cause 1970s stagflation?
- Cost-push shocks were central to 1970s stagflation: the 1973 and 1979 oil price spikes raised costs economy-wide, lifting US inflation above 11% while output contracted. The episode demonstrated that demand-management policy alone cannot resolve supply-driven inflation, reshaping how economists model supply disturbances in the Phillips curve.