Working Paper: NBER ID: w20569
Authors: Matthew Rognlie; Andrei Shleifer; Alp Simsek
Abstract: We present a model of investment hangover motivated by the Great Recession. In our model, overbuilding of residential capital requires a reallocation of productive resources to nonresidential sectors, which is facilitated by a reduction in the real interest rate. If the fall in the interest rate is limited by the zero lower bound and nominal rigidities, then the economy enters a liquidity trap with limited reallocation and low output. The drop in output reduces nonresidential investment through a mechanism similar to the acceleration principle of investment. The burst in nonresidential investment is followed by an even greater boom due to low interest rates during the liquidity trap. The boom in nonresidential investment induces a partial and asymmetric recovery in which the residential sector is left behind, consistent with the broad trends of the Great Recession.
Keywords: investment; liquidity trap; Great Recession
JEL Codes: E22; E32; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Overbuilding of residential capital (R31) | Reallocation of resources to nonresidential sectors (R33) |
| Reallocation of resources to nonresidential sectors (R33) | Low output (E23) |
| Low output (E23) | Reduced nonresidential investment (E20) |
| Fall in interest rate constrained by zero lower bound (E43) | Liquidity trap (E41) |
| Liquidity trap (E41) | Low output (E23) |
| Nonresidential investment recovery (E22) | Overall economic recovery (E66) |