This paper studies the effects of supply-side shocks that depress aggregate demand in a particularly marked way (known as Keynesian shocks). In particular, we consider a model in which the rise in layoffs in the recessionary phases of the economy increases the risk for households of having to reduce their consumption after job loss.
It is analytically shown how, in the theoretical model, greater fear of job loss in recessionary phases leads to an increase in household precautionary savings and can therefore generate shortfalls in aggregate demand following negative productivity shocks. It is also shown that the model is consistent with these Keynesian supply shocks when it is applied to data from relatively rigid labour markets, such as those of continental Europe.
