The Scars of Supply Shocks

50 Pages Posted: 2 Dec 2020

See all articles by Luca Fornaro

Luca Fornaro

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Barcelona Graduate School of Economics (Barcelona GSE)

Martin Wolf

University of Vienna - Department of Economics; Centre for Economic Policy Research (CEPR); University of St. Gallen; University of Bonn

Date Written: November 2020

Abstract

We study the effects of supply disruptions - for instance caused by the emergence of a pandemic - in an economy with Keynesian unemployment and endogenous productivity growth. By negatively affecting investment, even purely transitory negative supply shocks generate permanent output losses. The associated negative wealth effect depresses consumers' demand, which may even fall below the exogenous fall in supply. In this case, the optimal monetary policy response flips relative to conventional wisdom, as monetary expansions are needed to fight negative output gaps. If monetary policy is not expansionary enough a supply-demand doom loop emerges, causing a recession characterized by unemployment and weak productivity growth. Innovation policies, by fostering firms' investment, can restore full employment and healthy growth.

JEL Classification: E22, E31, E32, E52, E62, O42

Suggested Citation

Fornaro, Luca and Wolf, Martin and Wolf, Martin and Wolf, Martin and Wolf, Martin, The Scars of Supply Shocks (November 2020). CEPR Discussion Paper No. DP15423, Available at SSRN: https://ssrn.com/abstract=3737556

Luca Fornaro (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Martin Wolf

University of St. Gallen ( email )

Bodanstrasse 8
SIAW-HSG
St.Gallen, 9000
Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

University of Vienna - Department of Economics ( email )

Oskar-Morgenstern-Platz 1
Vienna, Vienna 1180
Austria

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