Final answer:
Supply shocks create problems for Keynesian stabilization policies by disrupting the balance between inflation and unemployment and shifting the aggregate supply curve. This leads to stagflation and complicates government efforts to stabilize the economy through fiscal measures, especially with the presence of sticky wages and prices.
Step-by-step explanation:
Supply shocks pose significant challenges to Keynesian stabilization policies, which are designed to manage aggregate demand in order to stabilize the economy. A supply shock, such as a sudden increase in oil prices, can cause stagflation, a situation where inflation and unemployment rise simultaneously. This scenario contradicts the typical trade-off between inflation and unemployment that Keynesian policies aim to balance through fiscal measures.
The core of Keynesian economics is the belief that recessions are primarily caused by insufficient aggregate demand, and it advocates for government intervention to stimulate or curb demand accordingly. However, supply shocks disrupt this approach by shifting the aggregate supply (AS) curve, affecting prices and output in ways that demand-side policies are less equipped to address. For example, positive supply shocks, like a decrease in energy prices, can help the economy by lowering unemployment and inflation, but negative supply shocks have the opposite effect.
Moreover, Keynesian policies can be hampered by sticky wages and prices, which take time to adjust. When faced with a supply shock, this stickiness can worsen the impact by delaying the economy's natural adjustment process. Additionally, the efficacy of Keynesian policies is limited by the time it takes for the government to enact fiscal changes and the challenge of accurately estimating potential GDP, further complicating the response to supply shocks.