Postwar Recessions Research Articles

The Role of Uncertainty in Jobless Recoveries

The three most recent downturns, in contrast with other post-war recessions, are characterized by slow recoveries in employment despite positive economic growth. I find that recent recoveries coincide with high uncertainty about economy-wide corporate profits at a time when output begins to rebound, a pattern that was not observed in the earlier recessions. To examine the role of uncertainty in jobless recoveries, I develop a dynamic stochastic general equilibrium model with search and matching frictions in the labor market and an intensive labor margin. The model is driven by productivity and time-varying volatility shocks. The uncertainty agents face is captured by time-varying volatility. Labor market search frictions generate costly labor adjustment. When an uncertainty shock hits the economy, firms reduce the number of vacancies posted because they are reluctant to make costly adjustments along the extensive margin. Instead, firms require more effort from their employees. This, along with positive productivity shocks, can result in jobless recoveries. I calibrate the model and show that, with the addition of uncertainty shocks, this model produces labor market dynamics that allows it to address recent episodes of jobless recoveries.

Are Recoveries All the Same: GDP and TFP?

Recessions and subsequent recoveries are frequently classified as “L-shaped” or “U-shaped,” with output losses in the former being permanent and losses in the latter at least partially made up by higher than average growth during the recovery. We estimate the probability of a U-shaped recovery for post-War NBER recessions. Most earlier recessions were U-shaped but more recent recessions have been L-shaped. The shape of recoveries is tracked relatively well by durable consumption, investment, and labor hours, with shapes suggested by nondurable consumption and employment being less well identified. Perhaps surprisingly, total factor productivity appears to recover rapidly after all recessions.

Crises in Economic Thought, Secular Stagnation, and Future Economic Research

Crises in Economic Thought, Secular Stagnation, and Future Economic Research

How Different Is This Time? Investigating the Declines of the U.S. Real GDP During the Great Recession

This paper investigates to what extent the declines of the U.S. real GDP are permanent during the Great Recession. Our trend-cycle decomposition indicates that the Great Recession is associated with a substantial permanent loss in the real GDP manifested in decelerated mean growth rate and lowered trend level. However, the cyclical component played a relatively minor role comparing to other post-war recessions. If the potential output grew at its pre-crisis rate, it could have been 4.5% higher at the end of the Great Recession.

Housing and the Business Cycle: Evidence from the UK Housing Price and Quantity

This paper investigates the importance of housing price and quantity variables in the UK business cycle since the mid 1950s. We start with a baseline Markov-switching common factor model for the UK economy into which we incorporate a house price variable (nationwide house price index) and a quantity variable (new housing starts) into the baseline model. Then, we evaluate the importance of the two housing market variables in the fluctuations of the overall economic activities. When house variables are allowed to directly affect the evolution of key macro indicators, the results are similar to those for the US in the previous studies: although the year-onyear housing quantity changes have significant on the UK business cycle beyond the three macro indicators, the usual yearon-year house price changes do not. However, asymmetric decreases in house price significantly affect the UK business cycle more than the asymmetric decreases in house quantity. When house variables are accommodated to influence the probabilities of transitions between expansions and contractions, we find strong evidence that changes in both house price and quantity variables significantly affect the switching of the UK economy between the two phases, although house quantity variables predict the upcoming business cycle phases better than house price. Moreover, for both house price and quantity variables, most useful information is contained in their asymmetric decreases.Keywords: Housing, Price, Quantity, UK, Business cycle, Markov-switchingJEL Classification: E21, E44, D41I. IntroductionThe extended period of sharp and continued house price increases, coupled with the booming investment in residential construction since the mid 90s has engendered a plethora of studies on the link between the housing market and the macroeconomy. As summarized in the satisfactory survey by Muellbauer and Murphy (2008), housing markets and the rest of the economy interact in multiple ways. However, if we concentrate on the of housing price on macroeconomic activities, we seem to have reached a wide consensus on the theoretical front. The effects channel emphasizes price appreciation, which causes subsequent increases in the wealth of homeowners, a direct extension of the permanent income hypothesis. More recent research, such as those by Aoki et aL (2004) and Iacoviello (2005), suggest that innovations in housing finance allow homeowners to use their homes as collateral to loosen their borrowing constraints.Unlike the general agreements revolving around the presence of the house price-macroeconomy relation in the theoretical front, the empirical evidence on the role of house prices over the business cycle remains mixed. For example, Davis and Heathcote (2005) find a contemporaneous correlation between the nationwide house prices in the US and output as high as 65% over the 1971-2001 period. However, Kan et aL (2004) find that the contemporaneous correlation between house prices and output growth is merely 15% or smaller on average in about 50 major US cities. Recently, Learner (2007) challenged the traditional view on the role of house prices, arguing that housing markets are grossly understudied by macroeconomists interested only in understanding business cycles. He reported several stylized facts about the behavior of the US housing market over the business cycle, claiming that i) housing investment leads the business cycle, and a fall in residential investment is a reliable harbinger of a recession, and ii) volumes, rather than prices, in the housing sector are what matter for business cycles. Supporting the second stylized fact, he pointed out that eight out of ten US postwar recessions have been preceded by substantial problems in quantity variables such as housing investment and consumer durables. Alvarez et aL (2009) (for the Eurozone) and Alvarez and Cabrero (2010) (for Spain) provided similar evidence highlighting the leading nature of housing market cycles with respect to business cycles, which reflects the cyclical features of a variety of housing market indicators such as hous- ing starts, housing permits, and the amount of residential investment. …

Facts and Challenges from the Great Recession for Forecasting and Macroeconomic Modeling

This paper provides a survey of business cycle facts, updated to take account of recent data. Emphasis is given to the Great Recession, which was unlike most other postwar recessions in the United States in being driven by deleveraging and financial market factors. We document how recessions with financial market origins are different from those driven by supply or monetary policy shocks. This helps explain why economic models and predictors that work well at some times do poorly at other times. We discuss challenges for forecasters and empirical researchers in light of the updated business cycle facts.

Business Cycles and Recessions in the OECD Area

Recessions are less frequent (10%), more volatile and less persistent than negative business cycles are (50%). In this article, OECD annual data are used to provide a taxonomy of postwar recessions, showing in particular the frequency, the features and the number of countries involved in major episodes. We shall also implement a simple way for inserting positive (or negative) growth cases into standard business cycle analysis, stressing in particular the importance of recessions for stabilization policies. This applies mostly to fiscal policies that risk otherwise to be more pro-cyclical than normally required.

The Politics of Economic Crisis in Historical‐Comparative Perspective

What pundits commonly call the “Great Recession” of 2008-09 was the most severe economic downturn experienced by the advanced capitalist countries of Western Europe and North America since the 1930s. According to the OECD, American GDP declined by 3.9% from the end of 2007 to the end of 2009. The UK fared worse than the US (-5.5%), France better (-2.8%) and Germany just about the same (-4.0%). Economic growth recovered in 2010, but the recovery has been weak by comparison to previous postwar recessions. As newspaper headlines remind us daily, sovereign-debt problems associated with global imbalances have held growth back, especially in the Euro-zone. We are certainly not “out of the woods” yet. Indeed, it seems likely that the recession of 2008-09 will in retrospect be seen as the beginning of a period of protracted stagnation and political as well as economic instability, in much the same way that the international recession of 1974-76 is commonly viewed. Current uncertainties notwithstanding, we consider this to be an opportune time to step back and take stock of how governments in the advanced capitalist countries responded to the Great Recession. In particular, it strikes us as useful to ask, “how is this time different?” The Great Depression provides an obvious reference point, but much has changed since the 1930s. In our view, it makes more sense to compare government responses to the Great Recession with government responses to the international recession of 1974-76 and structural economic problems in the second half of the 1970s. In pursuing this problematic, we will consider the experiences of France, Germany, Sweden, the UK and the US. With Sweden treated as a model of social-democratic capitalism, these five countries figure prominently in the comparative political economy literature (e.g., Gourevitch 1986).

The Statistical Behavior of GDP after Financial Crises and Severe Recessions

Do severe recessions associated with financial crises cause permanent reductions in potential GDP? If the economy eventually returns to its trend, does the return take longer than the return following recessions not associated with financial crises? We develop a statistical methodology appropriate for identifying and analyzing slumps, episodes that combine a contraction and an expansion and end when the economy returns to its trend growth rate. We analyze the Great Depression for the United States, severe and milder financial crises for advanced economies, severe financial crises for emerging markets, and postwar recessions for the United States and other advanced economies. The preponderance of evidence for episodes comparable with the current U.S. slump is that, while potential GDP is eventually restored, the slumps last an average of nine years. If this historical pattern holds, the Great Recession that started in 2007:Q4 will not ultimately affect potential GDP, but the Great Slump is not yet half over.

The Statistical Behavior of GDP after Financial Crises and Severe Recessions

Do severe recessions associated with financial crises cause permanent reductions in potential GDP, or does the economy return to its trend? If the economy eventually returns to its trend, does the return take longer than the return following recessions not associated with financial crises? We develop a statistical methodology that is appropriate for identifying and analyzing slumps, episodes that combine a contraction and an expansion, and end when the economy returns to its trend growth rate. We analyze the Great Depression of the 1930s for the U.S., severe and milder financial crises for advanced economics, severe financial crises for emerging markets, and postwar recessions for the U.S. and other advanced economies. The preponderance of evidence for episodes comparable with the current U.S. slump is that, while potential GDP is eventually restored, the slumps last an average of nine years. If this historical pattern holds, the Great Recession that started in 2007:4 will not ultimately affect potential GDP, but the Great Slump is not yet half over.

Factor analysis of permanent and transitory dynamics of the US economy and the stock market

We analyze dynamics of the permanent and transitory components of the U.S. economic activity and the stock market obtained by multivariate dynamic factor modeling. We capture asymmetries over the phases of economic and stock market trends and cycles using independent Markov-switching processes. We show that both output and stock prices contain significant transitory components, while consumption and dividends are useful to identify their respective permanent components. The extracted economic trend perfectly predicts all post-war recessions. Our results shed light to the nature of the bilateral predictability of the economy and the stock market. The transitory stock market component signals recessions with an average lead of one quarter, whereas the market trend is correlated with the economic trend with varying lead/lag times.

The UK Labour Market and the 2008-9 Recession

The recession of 2008–9 inflicted a larger cumulative loss of UK output than any of the other postwar recessions. Nevertheless, employment rates remained higher than might have been expected given the experience of previous recessions. The main reasons for this appear to be a combination of high firm profitability levels going into the recession, supportive monetary and fiscal policies during the recession, reductions in real producer wages and relatively buoyant real consumer wages. Unemployment had reached its lowest levels for 30 years going in to the latest recession and has also remained relatively subdued through the downturn, certainly compared to previous recessions. A combination of lower inflow rates into unemployment, allied with a relatively higher outflow rate into employment underlie this. As government support for the economy is scaled back, it may be however that it will take a long time for employment to return to levels last seen before the recession.

How does the US credit crisis affect the Asia–Pacific economies?—Analysis based on a general equilibrium model

The current financial crisis differs from most post-war recessions in that the balance sheets of both households and banks have been severely damaged, which could lead to structural changes in the behavior of households. Therefore, it may exert some far-reaching effects on regional economies in the short run as well as in the medium term. This paper studies these effects using a multi-country dynamic structural model. In the short run, the US credit crisis weighs heavily upon the Asia–Pacific economies through financial linkages in addition to the traditional trade channel due to the deepening global financial integration. The relative importance of various financial channels differs notably across economies. While stock market contagion is more important for advanced economies, flight to quality across borders plays a key role in less developed economies. From a medium-term perspective, changes in the US household behavior caused by the credit crisis can help correct global imbalances, but the effectiveness hinges largely upon how long US households can maintain a reasonably higher savings rate. In addition, although the declining American public savings rate may not exert material impacts on the global imbalances, it can darken regional growth prospects due to a potentially higher world real interest rate.

Macroeconomic Uncertainty and Asset Prices: A Stochastic Volatility Model

In this paper we measure time-varying uncertainty of macroeconomic variables and study the links to asset returns via a consumption-based asset pricing model. To this end, we introduce a stochastic volatility model and propose a Bayesian procedure identifying the model for multivariate processes. Novel features of our volatility setup include a unit root common factor and two asymptotic regimes with smooth transitions. We extract volatility factors from consumption and dividend growth rates and find that the common factor predicts post-war recessions quite well. Then, we develop and estimate a model of asset prices with the Epstein-Zin preferences and the macroeconomic uncertainty. The model provides an additional channel that generates a sizable risk premium for even a small amount of volatility because consumers may dislike uncertainty about regimes to which they will belong, especially if the perceived macroeconomic uncertainty unravels slowly. Our empirical results show that both the risk aversion and intertemporal elasticity of substitution are estimated around two, and the simulation results show that the model matches the first and the second moments of stock returns and the risk-free rate, hence the equity premium.

Demand and productivity components of business cycles: Estimates and implications

Standard stochastic growth models provide theoretical restrictions on output decomposition which can be used to investigate whether productivity shocks played a major role in observed business cycles. Applying these restrictions to US data leads to the following findings: (i) Business cycles implied by productivity shocks are mildly correlated to overall fluctuations and help account for a few episodes of US postwar recessions. However, only 20% of US fluctuations can be explained by these shocks. (ii) Most fluctuations seem instead to be due to “nominal demand” shocks, i.e. shocks which move output and prices in the same direction, but whose effects on output are ultimately transitory. (iii) Canonical sticky price models in the new-neoclassical synthesis tradition can account for the cyclical comovements of output and prices, but canonical, frictionless, RBC models cannot.

Common stochastic trends, common cycles, and asymmetry in economic fluctuations

This paper investigates the nature of U.S. business cycle asymmetry using a dynamic factor model of output, investment, and consumption. We identify a common stochastic trend and common transitory component by embedding the permanent income hypothesis within a simple growth model. Markov-switching in each component captures two types of asymmetry: Shifts in the growth rate of the common stochastic trend, having permanent effects, and “plucking” deviations from the common stochastic trend, having only transitory effects. Statistical tests suggest both asymmetries were present in post-war recessions, although the shifts in trend are less severe than found in the received literature.

Comment and Discussion

Comment and Discussion George L. Perry George L. Perry: William Nordhaus's paper covers several related aspects of the current economic scene: the recent recession and current recovery, the behavior of profits during and leading up to the recession, and the prospects for the stock market in the recovery. He offers provocative ideas on all fronts. Nordhaus compares the ten postwar recessions identified and dated by the NBER by examining four broad measures of economic loss: declines in real GDP, declines in employment, increases in unemployment, and positive output gaps as measured by the CBO. Output and employment declines track NBER-dated recessions very closely. Increases in unemployment lag these other measures of change, especially when measured over four quarters as in Nordhaus's figure 2, and this indicator yields several false-positive identifications of NBER recessions. The pattern of output gaps bears little relation to that of NBER recessions because these gaps usually remain positive for extended periods after a recession trough. However, if properly measured, the output gap would provide a summary indicator of overall economic loss. From this broad-brush comparison of recessions, Nordhaus draws both a particular and a general message. The particular message is that last year's recession was the mildest of the postwar period and that at its trough, which he takes to be the fourth quarter of 2001, the economy was virtually at its potential output. I will say more about that later. The general message is that the NBER's approach to recession dating is outdated: recessions differ so much in their severity and length that a richer classification scheme is called for; meanwhile advances in economic science and [End Page 221] data availability allow us to do a better job of classifying recessions than the pioneers of business cycle measurement were able to do. Nordhaus suggests developing quantitative criteria that would allow business cycle downturns to be classified more like hurricanes are, with several gradations reflecting their severity. Nordhaus gives the impression that a lot is at stake in refining our definition of recessions and applying more data to the task of identifying and classifying them. He hints that business-cycle dynamics could reflect the propagation of small impulses into large outcomes, so that identifying incipient virulent recessions would have important benefits. As a scientific matter, that is an important question and related to the more general question of whether periods of recession are special, in the sense that agents respond differently in recessions than at other times. That would be a reason to care a lot whether we were in or heading for such a period. If we could predict emerging weakness better, we should. But that goal is and always has been hotly pursued. It has nothing to do with classifying downturns according to severity after the fact. Turning to that more modest task, I agree with Nordhaus that the NBER should look not only at changes in but also at levels of economic activity in identifying recessions. And that criticism holds true even if we do not expand the NBER dating committee's limited mandate, which is to identify "a significant decline in activity spread across the economy " (emphasis added). I have always believed that one strength of recession dating by a committee of experts was that they were free to consider any and all evidence of recession. There were surely stretches in the first half of the 1930s when employment rose, but we all speak of that whole period as the Great Depression. And if we took away several months of dead-cat bounce in the economy that followed its precipitous decline in the fi rst half of 1980, the whole of 1980-82 would be one recession, not two as judged by the NBER. It felt like one recession at the time. I see no reason other than precedent for the experts to look only at whether measures such as sales and employment are falling in identifying when a recession starts and, more important, when it ends. However, going from principles to practice, I find the CBO output gap that Nordhaus uses in analyzing the level of economic utilization to be inadequate. The main problem...

Permanent and Transitory Components of Business Cycles: Their Relative Importance and Dynamic Relationship

This paper investigates the relationship between permanent and transitory components of U.S. recessions in an empirical model allowing for business cycle asymmetry. Using a common stochastic trend representation for real GNP and consumption, we divide real GNP into permanent and transitory components, the dynamics of which are different in booms vs. recessions. We find evidence of substantial asymmetries in postwar recessions, and that both the permanent and transitory component have contributed to these recessions. We also allow for the timing of switches from boom to recession for the permanent component to be correlated with switches from boom to recession in the transitory component. The parameter estimates suggest a specific pattern of recessions: switches in the permanent component lead switches in the transitory component both when entering and leaving recessions.

Permanent and Transitory Components of Business Cycles: Their Relative Importance and Dynamic Relationship

This paper investigates the relationship between permanent and transitory components of U.S. recessions in an empirical model allowing for business cycle asymmetry. Using a common stochastic trend representation for real GNP and consumption, we divide real GNP into permanent and transitory components, the dynamics of which are different in booms vs. recessions. We find evidence of substantial asymmetries in postwar recessions, and that both the permanent and transitory component have contributed to these recessions. We also allow for the timing of switches from boom to recession for the permanent component to be correlated with switches from boom to recession in the transitory component. The parameter estimates suggest a specific pattern of recessions: switches in the permanent component lead switches in the transitory component both when entering and leaving recessions.

Common Stochastic Trends, Common Cycles, and Asymmetry in Economic Fluctuations

This paper investigates the nature of business cycle asymmetry using a dynamic factor model of output, investment, and consumption. We first identify a common stochastic trend and a common transitory component by embedding the permanent income hypothesis within a simple growth model. We then investigate two types of asymmetry commonly identified in U.S. business cycle dynamics: (1) Infrequent negative permanent shocks, modeled as shifts in the growth rate of the common stochastic trend and (2) infrequent negative transitory shocks, modeled as "plucking" deviations from the common stochastic trend. Tests of marginal significance suggest both types of asymmetry were present in post-war recessions, although the shifts in trend are less severe than the received literature suggests.