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The scars of supply shocks

Luca Fornaro and Martin Wolf ()

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

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.

Keywords: Supply shocks; Covid-19; hysteresis; investment; endogenous growth; monetary policy; fiscal policy; zero lower bound; Keynesian growth. (search for similar items in EconPapers)
JEL-codes: E22 E31 E32 E52 E62 O42 (search for similar items in EconPapers)
Date: 2020-10, Revised 2021-04
New Economics Papers: this item is included in nep-mac and nep-mon
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Related works:
Working Paper: The Scars of Supply Shocks (2020) Downloads
Working Paper: The Scars of Supply Shocks (2020) Downloads
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