Sectoral supply and demand shocks during COVID-19: Evidence from Mexico

The COVID-19 pandemic has undeniably caused both supply and demand shocks. Nevertheless, it is uncertain to what extent each factor contributed more to the evolution of prices and economic activity at different points since the onset of the pandemic. Whether inflationary pressures are mainly due to demand or supply shocks is an important matter for the stance of monetary policy. By employing a sign-restricted SBVAR, we study supply and demand factors as potential sources of heterogeneity in sectoral performance of economic activity in Mexico. We find that during the peak contraction in 2020-2Q, the demand shock was the dominant source of fluctuation across most sectors. Moreover, we assess the extent to which economic activity responds to foreign shocks and find that domestic demand shocks are the primary drivers of GDP fluctuations in 2020-2Q, with external demand and supply conditions and exchange rate shocks also playing significant roles. In contrast, since the beginning of 2021, external supply has negatively contributed to the variation of several sectors, particularly in industrial production, whereas domestic and external demand factors have generally positively contributed.