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On Friday, June 19, 2020, Veronica Guerrieri joined the Princeton Bendheim Center for Finance to discuss recent research with Guido Lorenzoni, Ludwig Straub, and Ivan Werning on supply and demand shocks resulting from COVID-19.

Watch the full presentation below and download the slides here.  You can also watch all Markus’ Academy webinars on the Princeton BCF YouTube channel.

Executive Summary

A model that takes into account multiple sectors and an incomplete market is necessary to understand how to respond to COVID-19. Economies with multiple sectors and incomplete markets might make Keynesian supply shocks more likely, which in turn has implications for how the effects of the shock might amplify. See illustration of industry interconnectedness before the shock.

Ultimately, the authors argue the shock caused by the pandemic might have Keynesian demand features. Firm exit and job destruction might trigger changes in aggregate demand that are larger than the shocks themselves, aggravating the recession.

When we take multiple sectors and incomplete markets into account, we see how important social insurance is in responding to COVID-19. Monetary policy is important, but fiscal policy is crucial. With the right fiscal policy, we may not need to lower interest rates. See list of additional remarks on policy.