The Heterogenous Effects of Supply Shocks in Necessity Goods
with Tiago Bernardino, Saman Darougheh and Márcia Silva-Pereira
Abstract: We study the efficacy of price subsidies — implemented via lower value-added taxes —in addressing sectoral supply shocks in the presence of non-homothetic preferences and imperfect pass-through. In our heterogeneous-agent model, sectoral shocks generate recessions in both necessity and luxury goods, with necessity recessions imposing larger costs on the bottom 30% of the income distribution. A subsidy that lowers the price of necessity goods is welfare-reducing: high-income households respond disproportionately even though these goods account for a smaller share of their consumption. In contrast, cash transfers reduce the welfare losses associated with sectoral supply shocks. Central to our findings is that the model aligns closely with the empirically observed non-homothetic behavior of households and the imperfect pass-through, which we also document.
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