Working Paper: NBER ID: w20040
Authors: Lawrence J. Christiano; Martin S. Eichenbaum; Mathias Trabandt
Abstract: We argue that the vast bulk of movements in aggregate real economic activity during the Great Recession were due to financial frictions interacting with the zero lower bound. We reach this conclusion looking through the lens of a New Keynesian model in which firms face moderate degrees of price rigidities and no nominal rigidities in the wage setting process. Our model does a good job of accounting for the joint behavior of labor and goods markets, as well as inflation, during the Great Recession. According to the model the observed fall in total factor productivity and the rise in the cost of working capital played critical roles in accounting for the small size of the drop in inflation that occurred during the Great Recession.
Keywords: Great Recession; Financial Frictions; Zero Lower Bound; New Keynesian Model
JEL Codes: E1; E2; E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial wedge (G51) | economic downturn (F44) |
| financial wedge (G51) | employment (J68) |
| financial wedge (G51) | output (C67) |
| labor force participation rate (J49) | decline in employment (J63) |
| government consumption (E20) | economic activity (E20) |
| total factor productivity (D24) | inflation (E31) |
| working capital costs (G31) | inflation (E31) |
| financial wedge (G51) | macroeconomic variables (E19) |
| consumption wedge (D11) | macroeconomic variables (E19) |