How do firms respond to demand and supply shocks?

The study aims to identify the granular demand and productivity shocks, their properties, and the responses of the important firm-level variables to these shocks. We use comprehensive data from the Polish enterprise sector that cover the 2002-2019 period. As the data do not include prices, the identification of the demand shocks relies on the information on inventory changes. We utilize the control function approach to estimate the parameters of the production function and to identify productivity shocks. We use projection methods with granular data to identify the dynamic impulse-response function. We show that the distributions of the two shocks differ: i.e., supply (productivity) shocks are symmetrically distributed, and the distribution of demand shocks is negatively skewed. Moreover, both distributions have fat tails. Productivity shocks have much more persistent effect on firms' outcomes than demand shocks. Following demand shocks, there are short-lived increases in output, market share, productivity, real wages and markups; whereas investment and employment demand remain elevated for a longer period. We also find a very limited transmission of productivity into wages and we showed that proxies for prices increase after demand shocks, and they decrease after the supply shock, in a theory-consistent way.