Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?

Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub and Iván Werning

No 26918, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We present a theory of Keynesian supply shocks: supply shocks that trigger changes in aggregate demand larger than the shocks themselves. We argue that the economic shocks associated to the COVID-19 epidemic—shutdowns, layoffs, and firm exits—may have this feature. In one-sector economies supply shocks are never Keynesian. We show that this is a general result that extend to economies with incomplete markets and liquidity constrained consumers. In economies with multiple sectors Keynesian supply shocks are possible, under some conditions. A 50% shock that hits all sectors is not the same as a 100% shock that hits half the economy. Incomplete markets make the conditions for Keynesian supply shocks more likely to be met. Firm exit and job destruction can amplify the initial effect, aggravating the recession. We discuss the effects of various policies. Standard fiscal stimulus can be less effective than usual because the fact that some sectors are shut down mutes the Keynesian multiplier feedback. Monetary policy, as long as it is unimpeded by the zero lower bound, can have magnified effects, by preventing firm exits. Turning to optimal policy, closing down contact-intensive sectors and providing full insurance payments to affected workers can achieve the first-best allocation, despite the lower per-dollar potency of fiscal policy.

JEL-codes: E21 E32 E60 I18 (search for similar items in EconPapers)
Date: 2020-04
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pke
Note: EFG ME
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Citations: View citations in EconPapers (552)

Published as Veronica Guerrieri & Guido Lorenzoni & Ludwig Straub & Iván Werning, 2022. "Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?," American Economic Review, vol 112(5), pages 1437-1474.

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Journal Article: Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages? (2022)
Working Paper: Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages? (2020)
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