RDP 2025-04: HANK and the Transmission of Shocks to Demand and Supply 5. Supply and Demand Shocks

In this study, we consider one demand shock and two supply shocks to investigate their implications on consumption, employment, and other macroeconomic variables. In Section 6, we present and interpret the impact of these in the heterogeneous agent model and its representative agent counterpart, and examine in detail how transmission differs between the models. Comparisons of the aggregate responses to a number of additional shocks with and without heterogeneity are presented in Appendix A.

Positive demand shock:

  1. Monetary policy shock ( ω t M ) : This shock reflects a surprise reduction in the policy rate implemented by the central bank, unrelated to the endogenous evolution of inflation.

Negative supply shocks:

  1. Increased labour disutility (i.e. labour supply shock) ( ψ ) : This shock captures an increased household preference for leisure, leading to households supplying fewer labour hours to the market at a given wage with the trade-off of lower income and consumption. As a result, firms may need to increase wages to attract workers and maintain production, feeding into marginal costs and price setting, or alternatively may need to lower their level of production.
  2. Goods substitutability shock (i.e. mark-up shock) ( ε ) : This shock represents a decrease in the substitutability of intermediate goods in the production of the final consumption basket, and can be interpreted as individual goods in the CPI basket becoming less interchangeable. This shock can result in higher pricing power for firms, reducing households' purchasing power and potentially leading to a decline in consumption while allowing firms to maintain profits with a lower level of production.

By considering these various supply and demand shocks, we can assess the differential impacts on consumption, employment, and other macroeconomic variables within the HANK model. This analysis helps to deepen our understanding of the mechanisms through which these shocks shape the dynamics of the economy, with a particular focus on the distributional implications for different household groups.