Financial frictions, trends, and the great recession

Abstract

We study the causes behind the shift in the level of U.S. GDP following the Great Recession. To this end, we propose a model featuring endogenous productivity a la Romer and a financial friction a la Kiyotaki–Moore. Adverse financial disturbances during the recession and the lack of strong tailwinds post‐crisis resulted in a severe contraction and the downward shift in the economy's trend. Had financial conditions remained stable during the crisis, the economy would have grown at its average growth rate. From a historical perspective, the Great Recession was unique because of the size and persistence of adverse shocks, and the lackluster performance of favorable shocks since 2010. Endogenous productivity financial friction great recession liquidity shocks trend shift E22 E32 E37 G01 04