Belief-driven growth slowdowns and zero-bounded risk-free rate

Abstract

The literature presents mounting evidence that global long-run growth has been declining since the recession of 2008. Thus, to explore possible reasons for the growth slowdown and its risk-free rate and risk premium implications, this study constructs an endogenous growth model to examine the US economy before the 2008 recession and during the subsequent recovery period. The model features technological externalities that imply multiple perfect foresight balanced growth paths. In this setup, a change in agents’ beliefs may trigger persistent slumps, low interest rates, and elevated risk premium, consistent with the recent US experience. Numerically, using the Epstein and Zin preferences, the model calibration suggests that the historical data moments can be accommodated by persistent regimes and high intertemporal elasticity of substitution. Notably, the study’s simple-structured model with multiplicity and a regime-switching structure is a preliminary contribution to the field of economics, paving the way for future empirical studies.