New St. Louis Fed Reserve Working Paper: Measuring Sectoral Supply and Demand Shocks duringCOVID-19

The paper Measuring Sectoral Supply and Demand Shocks during COVID-19 was published in the Federal Reserve Bank of St. Louis Working Paper Series.

The on-going COVID-19 outbreak and subsequent health policy response have caused wide-spread disruption in most economies. On one hand, authorities around the world have enforced containment and mitigation measures that entailed the supervised shutdown of entire sectors of their economies. On the other hand, in face of health safety uncertainty, agents voluntarily self-impose social distancing.

There are many aspects that make studying this combined shock interesting. First, its unprecedented and unexpected nature. Second, the fact that it combined features that are traditionally associated with both demand and supply shocks. Third, the fact that its effect across sectors in the economy was extremely heterogeneous, with some industries shutting down almost completely (such as movie theaters), while others potentially benefiting from increased demand (such as general merchandise retailers). For many, it is not clear whether this is mostly a demand or a supply shock.

In this paper, we estimated Bayesian SVARs on the growth rates of hours worked and real wages for each major sector of the US economy. Our identification strategy, based on sign restrictions and informative priors, allowed us to estimate sequences of labor supply and demand shocks for each sector. Focusing on the on-going COVID-19 outbreak, we found that two-thirds of the fall in the growth rate of hours worked in March and April 2020 could be attributed to negative labor supply shocks. Most NAICS-2 sectors were subject to negative labor supply and demand shocks. One sector in particular — Leisure and Hospitality — was subject to historically large negative supply and demand shocks. Other sectors, such as Information and Retail Trade, experienced negligible supply shocks and, in some cases, positive demand shocks.

We showed that the size of our estimated supply shocks correlates with other measures, such as the fraction of jobs in each sector that can be performed from home. We believe that this serves as a validation of our shock identification strategy.

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