A Century of Gaps

Abstract

Was the US economy overheating already prior to 1929? Could this have been detected in real-time? Did the housing boom and bust of mid 1920s play the same role as it did in 2007? Results of our Bayesian macro-econometric US output trend-gap decomposition are presented in the tradition of comparative historical studies of causes leading to and subsequent dynamics of the 1929 and the 2007 crisis. Our results confirm the importance of financial factors as essential conditioning variables of output expansion and contraction in real-time. Accounting for credit growth, 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.