Supply and Demand in Disaggregated Keynesian Economies with an Application to the Covid-19 Crisis
We study supply and demand shocks in a general disaggregated model with multiple sectors, multiple factors, input-output linkages, downward nominal wage rigidities, credit-constraints, and a zero lower bound. We use the model to understand how the Covid-19 crisis, an omnibus of supply and demand shocks, affects output, unemployment, and inflation, and leads to the coexistence of tight and slack labor markets. Negative sectoral supply shocks are stagflationary, whereas negative sectoral demand shocks are deflationary. Furthermore, complementarities in production amplify Keynesian spillovers from negative supply shocks but mitigate them for negative demand shocks. In a stylized quantitative model of the US, we find supply and demand shocks each explain about half the reduction in real GDP. Although there is as much as 7% Keynesian unemployment, this is concentrated in certain markets. Hence, aggregate demand stimulus is less than half as effective as in a typical recession where all labor markets are slack.
Document Object Identifier (DOI): 10.3386/w27152