Working Paper: NBER ID: w28346
Authors: David Baqaee; Emmanuel Farhi
Abstract: The Covid-19 crisis is an unusual and seemingly all-encompassing economic shock. On the one hand, it was unquestionably a negative demand shock that, for fixed prices and incomes, reduced household spending. On the other hand, it was also unquestionably a negative supply shock that reduced firms' ability to maintain production at pre-pandemic prices and quantities. These negative shocks affected different industries differently: whereas some producers easily switched to remote-work and maintained both employment and production, industries that required face-to-face contact were forced to reduce production capacity and employment. We consider a stripped-down version of the model presented in Baqaee and Farhi (2020). Despite its simplicity, the model nevertheless allows for an arbitrary input-output network, complementarities in both consumption and production, incomplete markets, downward nominal wage rigidity, and a zero-lower bound. In this sense, it contains many of the ingredients typically considered to be important for understanding the economic fallout from Covid-19. Nevertheless, despite allowing for these realistic ingredients, this model has a stark property: factor income shares at the initial equilibrium are global sufficient statistics for the input-output network. This article clarifies clarifies what ingredients must be added to a model if the production network is to play an important role in the propagation of shocks.
Keywords: COVID-19; Keynesian Economics; Production Networks; Economic Shocks
JEL Codes: E0; E2; E3; E4; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Negative demand shocks (E31) | Decreased production and employment across various industries (L16) |
| Negative supply shocks (E31) | Decreased production and employment across various industries (L16) |
| COVID-19 crisis (H12) | Negative demand shocks (E31) |
| COVID-19 crisis (H12) | Negative supply shocks (E31) |
| Negative demand shocks (E31) | Propagation through supply chains (L81) |
| Negative supply shocks (E31) | Propagation through supply chains (L81) |
| Initial factor income shares (D33) | Response of welfare, inflation, and sectoral employment to shocks (D69) |