Disentangling Supply and Demand Shocks in a Networked Economy

Abstract

We develop a multi-sector general-equilibrium model with production networks that can be used to identify sector-level supply and demand shocks from observed price and output data. In our model, decreasing returns to scale in production create an upwardsloping supply curve at the sector level. Applying our model to the COVID-19 crisis in Japan, we find that negative demand shocks were the key driver of the economic downturn in 2020 and that negative supply shocks mitigated the decline in prices. We also find that sector-level demand stimulus can increase real GDP and that its effects depend importantly on targeted sectors.