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The recent boom-bust cycle: The relative contribution of capital flows, credit supply and asset bubbles

  • In't Veld, Jan
  • Raciborski, Rafal
  • Ratto, Marco
  • Roeger, Werner

We use an estimated open economy DSGE model with financial frictions for the US and the rest of the world to evaluate various competing explanations about the recent boom-bust cycle. We find that the savings glut hypothesis is insufficient for explaining all aspects of the boom in the US. Relatively strong TFP growth and expansionary monetary policy are also not able to explain fully the volatility of corporate and in particular residential investment. We identify bubbles in the stock and housing market as crucial. Concerning the downturn in 2008/2009, the fall in house prices and residential investment only plays a minor role. Mortgage defaults have more explanatory power, especially in a specification of the model with a segregated equity market. Finally, the bursting of the stock market bubble was at least as important in this recession as in 2001. Because of various negative shocks hitting the economy at the same time in 2008/2009 and continued positive technology growth, not only the real interest rate declined but inflation fell rapidly and left insufficient room for monetary policy to play a similar stabilising role as in previous recessions.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 55 (2011)
Issue (Month): 3 (April)
Pages: 386-406

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Handle: RePEc:eee:eecrev:v:55:y:2011:i:3:p:386-406
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