Citation

Discussion Paper Details

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Title: The Scars of Supply Shocks

Author(s): Luca Fornaro and Martin Wolf

Publication Date: November 2020

Keyword(s): COVID-19, Endogenous Growth, Fiscal policy, hysteresis, investment, Keynesian growth, monetary policy, Supply Shocks and zero lower bound

Programme Area(s): Macroeconomics and Growth and Monetary Economics and Fluctuations

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.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=15423

Bibliographic Reference

Fornaro, L and Wolf, M. 2020. 'The Scars of Supply Shocks'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=15423