Can negative supply shocks cause demand shortages? [pdf]
nber.org
nber.org
Abstract:
We present a theory of Keynesian supply shocks: supply shocks that trigger changes in aggregate demand larger than the shocks themselves. We argue that the economic shocks associated to the COVID-19 epidemic—shutdowns, layoffs, and firm exits—may have this feature. In one-sector economies supply shocks are never Keynesian. We show that this is a general result that extend to economies with incomplete markets and liquidity constrained consumers. In economies with multiple sectors Keynesian supply shocks are possible, under some conditions. A 50% shock that hits all sectors is not the same as a 100% shock that hits half the economy. Incomplete markets make the conditions for Keynesian supply shocks more likely to be met. Firm exit and job destruction can amplify the initial effect, aggravating the recession. We discuss the effects of various policies. Standard fiscal stimulus can be less effective than usual because the fact that some sectors are shut down mutes the Keynesian multiplier feedback. Monetary policy, as long as it is unimpeded by the zero lower bound, can have magnified effects, by preventing firm exits. Turning to optimal policy, closing down contact-intensive sectors and providing full insurance payments to affected workers can achieve the first-best allocation, despite the lower per-dollar potency of fiscal policy.
That's not considered a demand shortage in this context, because you're not necessarily holding on to more cash (the medium of exchange) simply because you've stopped going to restaurants. You might be dispensing of your cash in other ways.[0] It's a negative supply shock that's confined to the restaurant sector.
[0] (Yes, there is a multiplier effect but it goes both ways. The multiplier effect is a result of agents trying to keep to their preferred level of cash holdings while facing an outside change in the amount of monetary spending. It's really a "hot potato"/"frozen potato" effect: if agents are suddenly giving you more cash you'll want to spend the excess, and if no one is giving you any money you'll seek to restore your balance either by seeking cash from others or by curtailing your own spending.)
https://fred.stlouisfed.org/series/EXCSRESNS
The Fed even pays a small amount of interest. IOER is currently 0.1%
Does anyone understand the exact point being made?
The "liquidity constraints" discussed in the abstract may be one such friction, but it's quite common for agents to be liquidity-constrained or unwilling to incur debt even irrespective of any negative supply-shock, so it's not quite clear to me what points the paper is trying to make.
It also happens when oil prices get high and companies invest in oil saving technology that permanently reduces their demand.
> When workers lose their income, due to the shock, they reduce their spending, causing a contraction in demand. The question is whether this mechanism is strong enough to cause an overall shortfall in demand.
Answer:
> Positive, demand may indeed overreact to the supply shock and lead to a demand-deficient recession.
Suggested solution:
> The optimal policy to face a pandemic in our model combines a loosening of monetary policy as well as abundant social insurance.
Kind of like in 2008 when the macro guys woke up to the idea of a financial system as important and outside the existing model.
The federal funds rate is zero. So, direct injection of money seems the only way forward. Direct injection failed massively in the last recession where money was given to the markets but failed to reach the consumers. There is a lesson to learn there.
Europe approach in the current situation is to pay companies to keep citizens employed in combination with it’s already existing social protections. USA approach has been directed to assure companies capital to keep them for failing. The pandemic is an awful situation but a very interesting economic experiment. Time will tell the pros and cons of the different approaches.
I think the OP is alluding to the strategy of giving money directly to consumers, and particularly poor consumers (who tend to have a high MPC). This limits the pooling effect: it still happens, but it can't happen until the money has circulated throughout the economy a few times, which increases the stimulus effect for a given amount of inequality generated. As an added benefit, the effects are more immediate, which helps the central bank understand the consequences of its actions more rapidly and not have to act 18 months or so in advance of when the stimulus trickles down to real production.
Yes. I guess that I was not clear enough.
“ Wages in California have grown fastest for earners at the top of the income distribution. Wages for those in the bottom- and middle-income earners remained stagnant up until the recession and dropped until about 2014. As in the national data, low- and median-wage workers in California finally experienced wage growth that outpaced inflation starting in 2014. This was in part due to labor market tightening, but also due to state and local increases of the minimum wage.” https://irle.berkeley.edu/the-post-recession-labor-market-an...
Until 2014 there were no wage growth for bottom-middle income workers (California). That is a long fall. Meanwhile the markets recovered way faster.
We see this pattern repeating in this current crisis that just is starting. There has been a fast fall and fast asset valuation. But, employment has fallen fast but is recovering slower. It’s too soon to get to conclusions as is going to take years to see how the economy evolves. But, there is always lessons to be learned on how to improve the economy to all social strata from past mistakes.
That it's not primarily a supply shock (all kinds of products and raw materials are just as available as they were before the pandemic) is yet another indicator of the impact increased automation and labor efficiency in manufacturing has had. It's remarkable - and a bit frightening - how little human labor is required to provide a sufficient supply of goods to a huge number of people.
A huge number of jobs are engaged in verification/audit/fraud detection/related activities. "Paper pushers", the cliche goes.
An OK book that looks at this (and goes farther than I do, I think making some eventually unsupported claims) is _Bullshit Jobs_ by David Graeber. Worth a read - some of it is quite good.
Audit functions will always be needed. That said, I'm pretty sure there will be a lot of job functions that looked "normal" pre-C19, that people will decide no longer need doing, or will be done substantially differently after.
Agreed, and a lot of the rote work of auditing and fraud detection has been automated. But at some point, this devolves into the problem staying ahead of human adversaries, and that is hard to fully automate. Also, sometimes the slowness and inconsistency of human labor in these situations is itself a barrier to fraud.
I'm thinking of it more as a reset - there are a lot of job functions where things are done the way they are because that's how we do things. After pauses like this, people look at those with fresh eyes.
We're not consuming buffers (those were all cut long ago as "fat"), we're just lucky that the people responsible for logistics - who are right now forced to fly by the seat of their pants - are still managing to route goods around well enough for us to not notice, beyond an occasional shortage or price hike.
And, yet, we still insist that a "full time" employee has to work 40 hours a week, typically in the form of "butt in seat" time.
It's worth remembering that from the Western POV, the pandemic absolutely started with a supply shock - a big chunk of Chinese manufacturing essentially shut down for two months, and a lot of the usual cargo thus never sailed. This not only caused raising prices on all sorts of imported goods two months down the line (it takes as long for the container ships to reach Europe and the US), but also caused export problems - less incoming containers = less containers available to ship things back out. This coincided with the western governments instituting lockdowns and stay-at-home orders, resulting in reduced demand, which further forced the shippers to park their containers, cancel sailings, or even consider scrapping some capacity. Ocean shipping will take years to recover.
Supply and demand shocks are essentially two sides of the same coin, each 180 degrees in front of the other. They're oscillations in the system. We'll be facing repeated demand and supply shocks in the future, hopefully each with smaller magnitude than the previous one, until the whole system stabilizes again.
We saw the demand shock first, and because there's a demand shock, we don't see the supply shock. But if the reopening goes well, we're going to see massive shortages and inflation as all that pent-up demand chases goods that are sitting offshore on container ships or were never produced at all.
The choices of flour were briefly very limited, but now there's pretty much anything I'd want.
1. Looks interesting. Worthwhile type of thinking.
2. Control+F "savings" / "saving" ... no results. You'd think that the amount and distribution of savings in a population would greatly effect the outcomes.
That said, "elasticity" showed up 14 times in a control+f of the paper so it might be implicitly covered or named differently.
Edit: "reserve" / "reserves" had no relevant mentions (1x "rights reserved", 2x in citations of Federal Reserve), capital 0 mentions, "insurance" 14 mentions, "ability" 0 mentions, "willing" / "unwilling" / "willingness" 1 mention total, "substitute" / "substitution" 19 mentions, "bankrupt" / "bankruptcy" 0 mentions, "unemployment" 11 mentions, "funds" 0 mention, "cash" 0 mentions, "money" only 1 mention (!)... "monetary" shows up 20 times though.
Edit2: Lots of "utility function" going on. I personally don't really love the theoretical grounding of utility functions but it might actually produce interesting insights in this case.
Edit3: "Each agent is endowed with n > 0 units of labor which are supplied inelastically" - inelasticity of units of labor in this case seems like a pretty aggressive assumption. They carry that assumption through - "As before, agents inelastically supply labor n to their respective sector in the flexible price equilibrium; they may supply less than n in the equilibrium with wage rigidities. For now, we assume that workers are perfectly specialized in their sector."
Quite theoretical with a fair amount of simplifying assumptions to make it simpler to mathematically model. The conclusions are rather tentative and not strongly stated, in any event. Interesting line of thinking, I think you'd have to look closely at the assumptions and premises and how variables are defined to see if it corresponds well to real life.
But here's what they're investigating:
> ”In this paper, we introduce a concept that might be accurately portrayed as “supply creates its own excess demand”. Namely, a negative supply shock can trigger a demand shortage that leads to a contraction in output and employment larger than the supply shock itself."
They've got some time variables; I think an explicit savings variable (and maybe credit, too) would be important in determining whether that'd happen.
I might be mistaken, I tossed some quick thoughts up when this had zero comments, looking at methodology and assumptions moreso than conclusions. But you'd think regions with high-savings, low-savings but lots of credit, and low-savings combined with low credit would behave very differently towards "a contraction in output and employment larger than the supply shock itself."
Math gets way more complicated as you addd variables like that, though, and maybe it wouldn't effect the conclusions too much though, so... ¯\_(ツ)_/¯
" What happens if firms are liquidity constrained? If firms have some finite amount of liquidity at their disposal, say, because they cannot borrow nor issue equity and have limited past accumulated profits at their disposal, then they no longer maximize the present value of profits in an unconstrained fashion. This distorts firm decisions towards laying workers off, since the current period loss cannot be financed."