Abstract
In response to the COVID-19 lockdown policies, Guerrieri et al. (2020) developed a new concept: the Keynesian supply shock. A Keynesian supply shock is an aggregate supply shock that leads to an even larger aggregate demand shock. This paper suggests that Keynesian supply shocks are very similar to the secondary deflations suggested by Hayek (1931), and US data from the 2007–09 financial crisis show that these concepts may help to explain employment dynamics in the midst of a crisis. This fact implies that long-standing policy advice based on Austrian business cycle theory would be useful in responding to Keynesian supply shocks.
Highlights
In response to the COVID-19 lockdown policies, Guerrieri et al (2020) developed a new concept: the Keynesian supply shock
This paper suggests that there is a significant conceptual overlap between Keynesian supply shocks and Hayek’s concept of a “secondary deflation,” in which an initial crisis focused on the liquidation of malinvestments leads to economy-wide consequences (Hayek 1931)
In addition to explaining the theoretical overlap between Keynesian supply shocks and Hayekian secondary depressions, this paper will show that employment data from the United States during the 2007–09 financial crisis is more consistent with the Keynesian supply shock/Hayekian secondary deflation theory than is employment data from the 2020 COVID-19 lockdowns, which inspired Guerrieri et al (2020) to develop the Keynesian supply shock concept
Summary
Austrian business cycle theory is about a misallocation of resources between sectors (that is, “malinvestment”). (Since their model omits capital, they certainly would not be able to capture the process described by Austrian business cycle theory.) The Austrian explanation, is more comprehensive, but Guerrieri et al (2020) can provide a possible explanation for the link between the initial crisis and the broader effects in the secondary depression Another difference between the two approaches is the view of time. As an illustration of how a shock in one sector can create broader effects, as would be the case in a Keynesian supply shock or an Austrian secondary depression, consider the timing of employment effects during the 2007–09 financial crisis This crisis was caused by excessively low interest rates, which led to too many resources being directed toward investment in housing construction. While the data does not show a clear Keynesian supply shock, this shock could be occurring but not have appeared in the available data
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