2025/11/21 by Andrew Preston · 1 voice
Economics, Econometrics and Finance · #Economic Theory and Policy #Monetary Policy and Economic Impact #Economic theories and models
paper · doi:10.1093/ej/ueaf127
openalex publication_date 2025/11/21 · openalex created_date 2025/11/23 · openalex updated_date 2026/07/31
Abstract This paper develops a theory of how total factor productivity news shocks can affect the economy via a Keynesian supply channel. With frictional labour markets, bad total factor productivity news reduces firms’ incentive to post vacancies, worsening households’ employment prospects. Households respond by accumulating liquid assets and cutting spending for precautionary reasons, triggering a recession that compounds the labour-market downturn. This mechanism is outlined analytically and numerically in a heterogeneous-agent New Keynesian model, with supporting local-projection evidence. The combination of labour-market frictions and precautionary saving is necessary to match the joint output and nominal interest rate dynamics observed empirically following a news shock. In contrast to previous theories, the transmission mechanism leaves room for policy to mitigate the shock’s contractionary effects.