Macroeconomic implications of COVID-19: Can negative supply shocks cause demand shortages?
BibTeX
@article{guerrieri2022macroeconomic,
title={Macroeconomic implications of COVID-19: Can negative supply shocks cause demand shortages?},
author={Guerrieri, Veronica and Lorenzoni, Guido and Straub, Ludwig and Werning, Iv{\'a}n},
journal={American Economic Review},
volume={112},
number={5},
pages={1437--1474},
year={2022},
publisher={American Economic Association 2014 Broadway, Suite 305, Nashville, TN 37203}
}
Abstract
Motivated by the effects of the COVID-19 pandemic, we present a theory of Keynesian supply shocks: shocks that reduce potential output in a sector of the economy, but that, by reducing demand in other sectors, ultimately push aggregate activity below potential. A Keynesian supply shock is more likely when the elasticity of substitution between sectors is relatively low, the intertemporal elasticity of substitution is relatively high, and markets are incomplete. Fiscal policy can display a smaller multiplier, but the insurance benefit of fiscal transfers can be enhanced. Firm exits and job destruction can amplify and propagate the shock.
Notes and Excerpts
Supply shock to one sector reduces demand for those people from other sectors. Farmer has a bad harvest, and he spends less on clothes. Keynesian supply shock, where secondary shock results in economy falling below potential.
We can then interpret the pandemic as a large, asymmetric, transitory supply shock: the capacity of the economy to produce output without damaging people’s health has been temporarily but severely curtailed in some parts of the economy, less so in others
Competing effects from shutdown of a sector:
First, it makes it less attractive to spend overall and induces consumers to postpone spending to the future. Second, it induces consumers to reallocate their spending away from the shutdown sector and in favor of the sector still active
Then there is also the loss of income for workers in that sector.
They go on to talk about the implications for fiscal policy