Abstract

We study the impact that the liquidity crunch in 2008-2009 had on the U.S. economy's growth trend. To this end, we propose a model featuring endogenous growth á la Romer and a liquidity friction á la Kiyotaki-Moore. A key finding in our study is that liquidity declined around the demise of Lehman Brothers, which lead to the severe contraction in the economy. This liquidity shock was a tail event. Improving conditions in financial markets were crucial in the subsequent recovery. Had conditions remained at their worst level in 2008, output would have been 20 percent below its actual level in 2011.

Introduction

A few years into the recovery from the Great Recession, it is becoming clear that real GDP is failing to recover. Namely, although the economy is growing at pre-crisis growth rates, the crisis seems to have impinged a shift upon output. Figure 1 shows real GDP and its growth rate over the past decade. Without much effort, one can see that the economy is moving along a (new) trend that lies below the one prevailing in 2007. It is also apparent that if the economy continues to display the dismal post-crisis growth rates (blue dashed line), it will not revert to the old trend. Hence, this tepid recovery has spurred debate on whether the shift is permanent and if so what the long-term implications are for the economy. In this paper, we tackle the issue of the long-run impact of the Great Recession by means of a structural model.

2013.12

PDF File