Macroeconomic Implications of Covid-19: Can Negative Supply Shocks Cause Demand Shortages?
- American Economic Review (Forthcoming)
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.
Forthcoming Article Downloads