Working Paper: CEPR ID: DP14742
Authors: Emmanuel Farhi; David Rezza Baqaee
Abstract: We study the effects of negative supply shocks and shocks to the composition of final demand on aggregate output in a disaggregated neoclassical model with multiple sectors, factors, and input-output linkages. We show how nonlinearities associated with complementarities in consumption and production amplify the effect of negative supply shocks by creating supply bottlenecks and disrupting supply chain networks. These nonlinearities are particularly potent when the shocks are more heterogeneous as the worst-affected sectors drag down the other sectors. Nonlinearities are strengthened when changes in preferences lead households to tilt the composition of their demand towards the crippled sectors directly and indirectly through their supply chains. And nonlinearities are further intensified when factors cannot easily be reallocated across sectors to reinforce weak links. A quantitative investigation suggests that nonlinearities may amplify the impact of the Covid-19 shock by between 10%-100%, depending on the horizon of analysis and the exact size of the shocks.
Keywords: production networks; input-output linkages; complementarities; COVID-19
JEL Codes: E1; E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative supply shocks (E31) | supply bottlenecks (L99) |
| supply bottlenecks (L99) | disrupt supply chain networks (D85) |
| negative supply shocks (E31) | disrupt supply chain networks (D85) |
| worst-affected sectors (L52) | drag down other sectors (L59) |
| household preferences shift towards crippled sectors (D12) | amplify overall negative impact on output (F69) |
| inability to easily reallocate factors across sectors (P23) | exacerbate negative impacts of supply shocks (F41) |
| nonlinearities (C32) | amplify impact of COVID-19 shock (F69) |