A century of gaps: Untangling business cycles from secular trends

Abstract

Was the US economy overheating prior to 1929 and did financial factors play a similar part across the century? Did the housing boom and bust of mid 1920s play the same role as in the build up and subsequent crisis of 2007? We tackle these questions using a Bayesian macroeconometric trend-gap decomposition of U.S. output. Our analysis is presented in the tradition of comparative historical studies of the 1929 and 2007 crises. Results confirm the essential role of financial factors as conditioning variables estimating output gaps. Accounting for credit dynamics, U.S. potential output has been steadily expanding at roughly 2% since the beginning of 1980. The elasticity of output gaps with respect to credit gaps exhibits substantial time-variation.