Economists and policy-makers know, in a broad sense, how to respond to a negative shock to aggregate demand in an economy, like the financial meltdown leading to the Great Recession of 2007-09. The financial crisis shrinks demand in the economy, recession hits, and unemployment rises. The government can play a role in softening and shortening the recession through expansionary fiscal policy (spending increases and tax cuts) or monetary policy (lower interest rates). To be clear, this policy recipe is not about building robust long-term economic health, which would require thinking about education and job training, incentives for capital investment, research and development of new technology, and balancing the benefits and costs of regulation. But softening and shortening the immediate blow of recessions is a worthwhile objective.
But when the shocks that hit the economy are about about aggregate supply, like the pandemic recession, the policy prescriptions based on responding to demand shocks don’t apply as well. The key difference is that with a negative shock to aggregate demand, inflation is naturally tamped down, so when the government acts to stimulate the economy, there is little risk of inflation taking off. But in a negative shock to aggregate supply, unemployment rises and prices also start rising. Thus, if the government stimulates the economy, it can reduce immediate hardship, but at risk of driving inflation higher. Thus, there’s no inflationary pressure after the Great Recession, but there certainly was after the pandemic recession.
Peter R. Orszag, Eric Van Nostrand, Noah Barbieri, and Layla McDermott make a case that the US and world economy are experiencing a growing number and risk of supply-side shocks in “The New Supply-Side Era: The O-Ring Meets Geopolitics” (September 2026, also, a video of Orszag presenting the paper at the London School of Economics is available). They argue that the global economy has now experienced six supply-side shocks in the last six years: “[t]he pandemic, artificial intelligence, Russia’s invasion of Ukraine, tariff shocks, China’s rare-earth export controls, and the war in the Middle East.”
In addition, they add a complicating factor, what Michael Kremer (Nobel ’19) called the O-ring theory of development. After the space shuttle Challenger broke apart after liftoff in 1986, the study of what caused the crash focused on the O-rings, a rubber gasket used to seal a connection between two pipes. Apparently the rubber gasket became brittle when unusually cold, but this feature was not well-known at the time. The key insight of the O-ring theory of development is that the performance of a complex piece of machinery can be limited by the weakest component–even when everything else is going just fine. The pandemic revealed various O-rings in the US economy, like the cargo ships sitting offshore and waiting to offload. The authors write:
One weak link can reduce or destroy the value of everything else. That multiplicative structure is what makes today’s economy so exposed to supply shocks: as products became more complex, a generation of globalization built long supply chains, and a problematic input at one stage—a chip, a mineral, a precursor chemical—can shut down production far beyond it. These supply shocks behave quite differently from the textbook demand cycle. Their effects develop slowly, propagate through supply chains in waves—delivery delays, then input shortages, then margin compression, then price pass-through—and unwind with long and uneven lags. … What distinguishes the new era is thus not necessarily the blast radius of any single shock, but instead their frequency and overlap. Disruptions (especially in energy) may tend to have smaller effects than those of their historical counterparts, but they arrive more often and, increasingly, on top of one another.
To put it another way, the prevailing gestalt a few decades back was that truly important supply shocks were relatively rare. The modern a parade of supply shocks coming thick and fast in a more interconnected global economy–where some of the interconnections impose O-ring constraints and costs.
Orszag, Nostrand, Barbieri, and McDermott also emphasize that many of these O-ring constraints are physical or geographic: shortages of key components, the capacity of ports, an underwater seabed cable severed, a chokepoint for the passage of shipping, a country with most of the world’s capacity to refine rare earth materials (China) or producing the highest-end computer chips (Taiwan), or even tanks and planes crossing a border. A string of six major supply-side disruptions in six years, at times interrelated and reinforcing each other, starts to look less like “bad luck” and more like “the way things are going to be.” The authors argue that economists and economics are being pushed into a world where we need to think as “geopolitical supply-siders,” attuned to the prevalence of supply-side shocks and how they propagate through an economy.
The pandemic recession was a classic
