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The stock market crash of 2008 caused the Great Recession: Theory and evidence

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  • Farmer, Roger E.A.

Abstract

This paper argues that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession. The paper has three parts. First, it provides evidence of a high correlation between the value of the stock market and the unemployment rate in U.S. data since 1929. Second, it compares a new model of the economy developed in recent papers and books by Farmer, with a classical model and with a textbook Keynesian approach. Third, it provides evidence that fiscal stimulus will not permanently restore full employment. In Farmer's model, as in the Keynesian model, employment is demand determined. But aggregate demand depends on wealth, not on income.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 36 (2012)
Issue (Month): 5 ()
Pages: 693-707

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Handle: RePEc:eee:dyncon:v:36:y:2012:i:5:p:693-707

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Unemployment; Keynesian economics; The stock market;

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References

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  1. Martin Lettau & Sydney C. Ludvigson, 2011. "Shocks and Crashes," NBER Working Papers 16996, National Bureau of Economic Research, Inc.
    • Martin Lettau & Sydney C. Ludvigson, 2013. "Shocks and Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2013, Volume 28, pages 293-354 National Bureau of Economic Research, Inc.
  2. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  3. Jean-Paul Fitoussi & David Jestaz & Edmund S Phelps & Gylfi Zoega, 2000. "Roots of the Recent Recoveries: Labor Reforms or Private Sector Forces?," Sciences Po publications info:hdl:2441/5571, Sciences Po.
  4. Farmer, Roger, 2010. "Expectations, Employment and Prices," OUP Catalogue, Oxford University Press, number 9780195397901, September.
  5. Roger E.A. Farmer, 2009. "Confidence, Crashes and Animal Spirits," NBER Working Papers 14846, National Bureau of Economic Research, Inc.
  6. Paul Gomme & B. Ravikumar & Peter Rupert, 2006. "The Return to Capital and the Business Cycle," 2006 Meeting Papers 801, Society for Economic Dynamics.
  7. Roger Farmer & Dmitry Plotnikov, 2012. "Does Fiscal Policy Matter? Blinder and Solow Revisited," 2012 Meeting Papers 73, Society for Economic Dynamics.
  8. Farmer, Roger E A, 2010. "Animal Spirits, Persistent Unemployment and the Belief Function," CEPR Discussion Papers 8100, C.E.P.R. Discussion Papers.
  9. Martin Lettau & Sydney C. Ludvigson, 2004. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," American Economic Review, American Economic Association, vol. 94(1), pages 276-299, March.
  10. Laurence Ball, 1999. "Aggregate demand and Long-Run Unemployment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 189-252.
  11. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, July.
  12. Farmer, Roger E. A., 2014. "How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies," OUP Catalogue, Oxford University Press, number 9780199360307, September.
  13. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  14. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  15. Edmund S. Phelps, 1999. "Behind This Structural Boom: The Role of Asset Valuations," American Economic Review, American Economic Association, vol. 89(2), pages 63-68, May.
  16. Beyer, Andreas & Farmer, Roger E A, 2003. "Identifying the Monetary Transmission Mechanism Using Structural Breaks," CEPR Discussion Papers 4106, C.E.P.R. Discussion Papers.
  17. Olivier J. Blanchard, 1986. "Hysteresis and Unemployment," Working papers 430, Massachusetts Institute of Technology (MIT), Department of Economics.
  18. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
  19. Hoon, Hian Teck & Phelps, Edmund S, 1992. "Macroeconomic Shocks in a Dynamized Model of the Natural Rate of Unemployment," American Economic Review, American Economic Association, vol. 82(4), pages 889-900, September.
  20. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  21. Farmer, Roger E.A., 2010. "How to reduce unemployment: A new policy proposal," Journal of Monetary Economics, Elsevier, vol. 57(5), pages 557-572, July.
  22. Beyer, Andreas & Farmer, Roger E. A., 2002. "Natural rate doubts," Working Paper Series 0121, European Central Bank.
  23. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," Working papers 427, Massachusetts Institute of Technology (MIT), Department of Economics.
  24. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
  25. Keith M. Carlson & Roger W. Spencer, 1975. "Crowding out and its critics," Review, Federal Reserve Bank of St. Louis, issue Dec, pages 2-17.
  26. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
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Cited by:
  1. Jianjun Miao & PENGFEI WANG & Lifang Xu, 2012. "Stock Market Bubbles and Unemployment," Boston University - Department of Economics - Working Papers Series WP2012-011, Boston University - Department of Economics.
  2. Makoto Nakajima, 2013. "The diverse impacts of the great recession," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 17-29.
  3. Roger E. A. Farmer, 2012. "The Evolution of Endogenous Business Cycles," Working Papers 302012, Hong Kong Institute for Monetary Research.
  4. Laurent Ferrara & Clément Marsilli, 2012. "Financial variables as leading indicators of GDP growth: Evidence from a MIDAS approach during the Great Recession," EconomiX Working Papers 2012-19, University of Paris West - Nanterre la Défense, EconomiX.
  5. Luis A. Gil-Alana & Juncal Cuñado & Guglielmo Maria Caporale, 2012. "Modelling Long Run Trends and Cycles in Financial Time Series Data," Faculty Working Papers 13/12, School of Economics and Business Administration, University of Navarra.

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