Working Paper: NBER ID: w21719
Authors: Julian Kozlowski; Laura Veldkamp; Venky Venkateswaran
Abstract: The Great Recession was a deep downturn with long-lasting effects on credit, employment and output. While narratives about its causes abound, the persistence of GDP below pre-crisis trends remains puzzling. We propose a simple persistence mechanism that can be quantfied and combined with existing models. Our key premise is that agents don't know the true distribution of shocks, but use data to estimate it non-parametrically. Then, transitory events, especially extreme ones, generate persistent changes in beliefs and macro outcomes. Embedding this mechanism in a neoclassical model, we find that it endogenously generates persistent drops in economic activity after tail events.
Keywords: beliefs; persistent stagnation; tail risk; Great Recession
JEL Codes: D84; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Great Recession (G01) | belief revisions (D83) |
| belief revisions (D83) | economic activity (E20) |
| Great Recession (G01) | persistent drops in output (D39) |
| belief revisions (D83) | persistent low economic activity (E29) |
| tail events (Y60) | belief revisions (D83) |
| tail events (Y60) | economic responses (E65) |