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We study supply and demand shocks in a disaggregated model with multiple sectors, multiple factors, input-output linkages, downward nominal wage rigidities, credit-constraints, and a zero lower bound. We use the model to understand how the COVID-19 crisis, an omnibus supply and demand shock, affects output, unemployment, and inflation, and leads to the coexistence of tight and slack labor markets. We show that negative sectoral supply shocks are stagflationary, whereas negative demand shocks are deflationary, even though both can cause Keynesian unemployment. Furthermore, complementarities in production amplify Keynesian spillovers from supply shocks but mitigate them for demand shocks. This means that complementarities reduce the effectiveness of aggregate demand stimulus. In a stylized quantitative model of the United States, we find supply and demand shocks each explain about one-half of the reduction in real GDP from February to May 2020. Although there was as much as 6 percent Keynesian unemployment, this was concentrated in certain markets. Hence, aggregate demand stimulus is one quarter as effective as in a typical recession where all labor markets are slack. (JEL E12, E23, E24, E31, E32, E62, I12)
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Inflation and Asset Returns
The past half-century has seen major shifts in inflation expectations, how inflation comoves with the business cycle, and how stocks comove with Treasury bonds. Against this backdrop, we review the economic channels and empirical evidence on how inflation is priced in financial markets. Not all inflation episodes are created equal. Using a New Keynesian model, we show how “good” inflation can be linked to demand shocks and “bad” inflation to cost-push shocks driving the economy. We then discuss asset pricing implications of “good” and “bad” inflation. We conclude by providing an outlook for inflation risk premia in the world of newly rising inflation.
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- Award ID(s):
- 2149193
- PAR ID:
- 10512701
- Publisher / Repository:
- Annual Reviews
- Date Published:
- Journal Name:
- Annual Review of Financial Economics
- Volume:
- 15
- Issue:
- 1
- ISSN:
- 1941-1367
- Page Range / eLocation ID:
- 433 to 448
- Format(s):
- Medium: X
- Sponsoring Org:
- National Science Foundation
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- Free Publicly Accessible Full Text
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Accepted Manuscript1.0
- Journal Article:
- https://doi.org/10.1146/annurev-financial-110921-104726
