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

  • Farmer, Roger E.A.

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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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
DOI: 10.1016/j.jedc.2012.02.003
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  1. Beyer, Andreas & Farmer, Roger E. A., 2003. "Identifying the monetary transmission mechanism using structural breaks," Working Paper Series 0275, European Central Bank.
  2. Farmer, Roger, 2010. "How the Economy Works: Confidence, Crashes, and Self-Fulfilling Prophecies," OUP Catalogue, Oxford University Press, number 9780195397918, December.
  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 E A & Plotnikov, Dmitry, 2011. "Does Fiscal Policy Matter? Blinder and Solow Revisited," CEPR Discussion Papers 8189, C.E.P.R. Discussion Papers.
  5. 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.
  6. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis in Unemployment," NBER Working Papers 2035, National Bureau of Economic Research, Inc.
  7. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
  8. Jean-Paul Fitoussi & David Jestaz & Edmund S Phelps & Gylfi Zoega, 2000. "Roots of the Recent Recoveries: Labor Reforms or Private Sector Forces?," Post-Print hal-01011185, HAL.
  9. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  10. Farmer, Roger E A, 2000. "Natural Rate Doubts," CEPR Discussion Papers 2426, C.E.P.R. Discussion Papers.
  11. 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.
  12. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  13. Roger E.A. Farmer, 2010. "Animal Spirits, Persistent Unemployment and the Belief Function," NBER Working Papers 16522, National Bureau of Economic Research, Inc.
  14. Roger E.A. Farmer (ed.), 2008. "Macroeconomics in the Small and the Large," Books, Edward Elgar Publishing, number 13236, March.
  15. Farmer, Roger, 2010. "Expectations, Employment and Prices," OUP Catalogue, Oxford University Press, number 9780195397901, December.
  16. Paul Gomme & B. Ravikumar & Peter Rupert, 2006. "The return to capital and the business cycle," Working Paper 0603, Federal Reserve Bank of Cleveland.
  17. 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.
  18. Thomas Lubik & Frank Schorfheide, 2002. "Testing for Indeterminacy:An Application to U.S. Monetary Policy," Economics Working Paper Archive 480, The Johns Hopkins University,Department of Economics, revised Jun 2003.
  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. 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.
  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. 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.
  23. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  24. Keith M. Carlson & Roger W. Spencer, 1975. "Crowding out and its critics," Review, Federal Reserve Bank of St. Louis, issue Dec, pages 2-17.
  25. 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.
  26. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, September.
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