Can negative supply shocks cause demand shortages? [pdf]

https://www.nber.org/papers/w26918.pdf

by wallflower • 6 years ago

45 40 6 years ago

Quick take on a first skim and thinking:

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.

jmalicki2• 6 years ago

Savings is implied through extensive discussion of marginal propensities to consume (MPC) - the fraction of additional income that a person will NOT save.

lionhearted2• 6 years ago

That's right, yeah.

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)_/¯

downerending4• 6 years ago

I wonder how this plays out in the real world. Restaurants have suddenly become unavailable, my demand for them has dropped precipitously, they become available again, but I don't see myself reverting to my prior demand for years, if ever.

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.

zozbot2346• 6 years ago

Restaurants have suddenly become unavailable, my demand for them has dropped precipitously, they become available again, but I don't see myself reverting to my prior demand for years, if ever.

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.)

downerending4• 6 years ago

I'm not an economist, but I actually am holding onto the cash (putting it in savings). Yes, I'll probably ultimately spend it on something else but not for decades.

JamesBarney• 6 years ago

They call this demand destruction.

It also happens when oil prices get high and companies invest in oil saving technology that permanently reduces their demand.

bachmeier• 6 years ago

If you want to see Ivan Werning's presentation: https://www.youtube.com/watch?v=-PkK9IlTHVM

tropdrop• 6 years ago

This is a quick sum of the study's basic intuition:

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.

thedudeabides5• 6 years ago

Yeah it a lot of math to propose a link between supply shocks (where everyone to get fired) and demand (via employment).

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.

Hokusai2• 6 years ago

loosening of monetary policy

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.

zozbot2346• 6 years ago

Monetary loosening did not fail post-2008 recession, except to the extent that it wasn't really tried in the first place. Whenever aggressive monetary loosening was done, even by unconventional means, the market responses in the forex, stock and even in the bond markets were very clear. (Contrary to common misconceptions, loose monetary policy should not be expected to cause low rates in e.g. the bond market; low market rates occur when money has been too tight, and interest-rate based monetary policy works like stabilizing an unstable system, so pushing market rates higher requires setting the policy rate even lower!)

jb775• 6 years ago

I think the public narrative not being kept congruent with actual supply levels is the main factor at play here. If everyone's talking about a shortage of toilet paper, you initially rush out to buy extra toilet paper, but can't find any. You continue to see dialogue of "toilet paper shortage", and figure it's not even worth the effort to walk down that aisle, but for all you know your local store is fully stocked.

perl4ever• 6 years ago

The grocery store I go to has had limits on paper towels, toilet paper, flour, etc. to one per customer per day for I think months and that seems to have solved the problem.

The choices of flour were briefly very limited, but now there's pretty much anything I'd want.

ouid2• 6 years ago

The pandemic is not primarily a supply shock. It is primarily a demand shock. People aren't going outside.

danans2• 6 years ago

The pandemic is not primarily a supply shock. It is primarily a demand shock. People aren't going outside.

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.

_jal2• 6 years ago

It's remarkable - and a bit frightening - how little human labor is required

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.

erik_seaberg• 6 years ago

We aren't providing sufficient goods. We're consuming a backlog that was already produced and waiting, and that won't last.

pmiller22• 6 years ago

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.

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.

TeMPOraL2• 6 years ago

It is an oscillation between a supply shock and a demand shock, and back again. Multiple so-called "bullwhip effects" stacked on top of each other, all across the various sectors in the economy.

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.

nostrademons3• 6 years ago

It's both, but operating on different timescales. Friends of mine who operate in old-line businesses (packaging and hot tubs) tell me that supply chains are in shambles right now. They can sell things, but there's nothing to sell, because critical parts or ingredients just aren't available. This is all masked right now because few people are buying anything.

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.

ouid2• 6 years ago

It's pretty hard to establish causality, but there is one way I know of establishing that A did not cause B. In particular, if A came after B, then A did not cause B. If sending signals back in time was possible, the hedge funds would have figured it out. If the demand shock happened first, then it wasn't caused by the supply shock.

Can negative supply shocks cause demand shortages? [pdf]

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