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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

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8617.

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Date of creation: Oct 2011
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Handle: RePEc:cpr:ceprdp:8617

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Keywords: stock market; unemployment;

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References

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  1. Beyer, Andreas & Farmer, Roger E. A., 2002. "Natural rate doubts," Working Paper Series 0121, European Central Bank.
  2. Beyer, Andreas & Farmer, Roger E. A., 2003. "Identifying the monetary transmission mechanism using structural breaks," Working Paper Series 0275, European Central Bank.
  3. 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..
  4. Farmer, Roger, 2010. "Expectations, Employment and Prices," OUP Catalogue, Oxford University Press, number 9780195397901.
  5. Paul Gomme & B. Ravikumar & Peter Rupert, 2011. "The Return to Capital and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 262-278, April.
  6. Farmer, Roger, 2010. "How the Economy Works: Confidence, Crashes, and Self-Fulfilling Prophecies," OUP Catalogue, Oxford University Press, number 9780195397918.
  7. Keith M. Carlson & Roger W. Spencer, 1975. "Crowding out and its critics," Review, Federal Reserve Bank of St. Louis, issue Dec, pages 2-17.
  8. 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.
  9. Martin Lettau & Sydney Ludvigson, 2003. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," NBER Working Papers 9848, National Bureau of Economic Research, Inc.
  10. Olivier J. Blanchard, 1986. "Hysteresis and Unemployment," Working papers 430, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Farmer, Roger E A & Plotnikov, Dmitry, 2011. "Does Fiscal Policy Matter? Blinder and Solow Revisited," CEPR Discussion Papers 8189, C.E.P.R. Discussion Papers.
  12. Fitoussi, J-P & Jestaz, D. & Phelps, E.S. & Zoega, G., 2000. "Roots of the Recent Recoveries : Labor Reforms or Private-Sector Forces ?," Documents de Travail de l'OFCE 2000-04, Observatoire Francais des Conjonctures Economiques (OFCE).
  13. 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.
  14. Roger E. A. Farmer, 2011. "Confidence Crashes and Animal Spirits," 2011 Meeting Papers 603, Society for Economic Dynamics.
  15. 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.
  16. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis And The European Unemployment Problem," NBER Chapters, in: NBER Macroeconomics Annual 1986, Volume 1, pages 15-90 National Bureau of Economic Research, Inc.
  17. 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.
  18. Martin Lettau & Sydney C. Ludvigson, 2011. "Shocks and Crashes," NBER Working Papers 16996, National Bureau of Economic Research, Inc.
  19. 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.
  20. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1.
  21. 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.
  22. 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.
  23. 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.
  24. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
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Cited by:
  1. Guglielmo Maria Caporale & Juncal Cuñado & Luis A. Gil-Alana, 2013. "Modelling long-run trends and cycles in financial time series data," Journal of Time Series Analysis, Wiley Blackwell, vol. 34(3), pages 405-421, 05.
  2. Pengfei Wang & Lifang Xu & Jianjun Miao, 2013. "Stock Market Bubbles and Unemployment," 2013 Meeting Papers 720, Society for Economic Dynamics.
  3. Makoto Nakajima, 2013. "The diverse impacts of the great recession," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 17-29.
  4. Laurent Ferrara & Clément Marsilli, 2013. "Financial variables as leading indicators of GDP growth: Evidence from a MIDAS approach during the Great Recession," Applied Economics Letters, Taylor & Francis Journals, vol. 20(3), pages 233-237, February.

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