Supply and Demand in Disaggregated Keynesian Economies with an Application to the COVID-19 Crisis

We study supply and demand shocks in a 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 supply and demand shock, affects output, unemployment, and inflation, and leads to the coexistence of tight and slack labor markets. We show that negative sectoral supply shocks are stagflationary, whereas negative demand shocks are deflationary, even though both can cause Keynesian unemployment. Furthermore, complemenlarities in production amplify Keynesian spillovers from supply shocks but mitigate them for demand shocks. This means that complementarities reduce the effectiveness of aggregate demand stimulus. In a stylized quantitative model of the United States, we find supply and demand shocks each explain about one-half of the reduction in real GDP from February to May 2020. Although there was as much as 6 percent Keynesian unemployment, this was concentrated in certain markets. Hence, aggregate demand stimulus is one quarter as effective as in a typical recession where all labor markets are slack.

Policies for a second wave

In the spring of 2020, the initial surge of COVID-19 infections and deaths was flattened using a combination of economic shutdowns and noneconomic non-pharmaceutical interventions (NPIs). The possibility of a second wave of infections and deaths raises the question of what interventions can be used to significantly reduce deaths while supporting, not preventing, economic recovery. We use a five-age epidemiological model combined with sixty-six-sector economic accounting to examine policies to avert and to respond to a second wave. We find that a second round of economic shutdowns alone are neither sufficient nor necessary to avert or quell a second wave. In contrast, noneconomic NPIs, such as wearing masks and personal distancing, increasing testing and quarantine, reintroducing restrictions on social and recreational gatherings, and enhancing protections for the elderly together can mitigate a second wave while leaving room for an economic recovery. © 2020, Brookings Institution Press. All rights reserved.