Supply constraints in a heterogenous agents household demand model: a method for assessing the direct impact of the COVID lockdown

The COVID pandemic has led to worldwide short-term lockdowns that mostly affected services with personal contact. In economic terms, the lockdown represents a supply shock that simultaneously leads to a demand restriction. The direct effect of the supply constraint is a change in both the structure and the level of consumption. The critical issue for the level effect is the rebound of total consumption, when the lockdown is over. In a model with heterogenous agents that exhibit different consumption structures and different behavior at the aggregate level (‘permanent income hypothesis’ consumers vs. liquidity constrained consumers), the rebound is not complete within the same period, but only over t and t + 1. In the first year, negative aggregate consumption effects are observed. The supply constraints act at the level of single goods and induce large changes in the level of consumption in both directions. This aspect of structural adjustment that occurs without aggregate changes, is an underrepresented issue in the current policy debate. This paper presents a method of consistent implementation of supply constraints via exogenous variables in a nested demand system and of calculating the direct consumption impact across household income groups.