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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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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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  1. 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.
  2. Paul Gomme & B. Ravikumar & Peter Rupert, 2006. "The return to capital and the business cycle," Working Paper 0603, Federal Reserve Bank of Cleveland.
  3. Roger E.A. Farmer, 2010. "Animal Spirits, Persistent Unemployment and the Belief Function," NBER Working Papers 16522, National Bureau of Economic Research, Inc.
  4. 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.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  6. Farmer, Roger E A, 2000. "Natural Rate Doubts," CEPR Discussion Papers 2426, C.E.P.R. Discussion Papers.
  7. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis in Unemployment," NBER Working Papers 2035, National Bureau of Economic Research, Inc.
  8. Roger E.A. Farmer & Dmitry Plotnikov, 2010. "Does Fiscal Policy Matter? Blinder and Solow Revisited," NBER Working Papers 16644, National Bureau of Economic Research, Inc.
  9. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
  10. 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.
  11. Roger E.A. Farmer (ed.), 2008. "Macroeconomics in the Small and the Large," Books, Edward Elgar, number 13236, July.
  12. 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.
  13. 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.
  14. Farmer, Roger E. A., 2014. "How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies," OUP Catalogue, Oxford University Press, number 9780199360307, March.
  15. 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).
  16. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, Abril.
  17. 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.
  18. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  19. Farmer, Roger, 2010. "Expectations, Employment and Prices," OUP Catalogue, Oxford University Press, number 9780195397901, March.
  20. Roger E. A. Farmer, 2011. "Confidence Crashes and Animal Spirits," 2011 Meeting Papers 603, Society for Economic Dynamics.
  21. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," Working papers 427, Massachusetts Institute of Technology (MIT), Department of Economics.
  22. 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.
  23. 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.
  24. Beyer, Andreas & Farmer, Roger E. A., 2003. "Identifying the monetary transmission mechanism using structural breaks," Working Paper Series 0275, European Central Bank.
  25. 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.
  26. 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.
  27. Keith M. Carlson & Roger W. Spencer, 1975. "Crowding out and its critics," Review, Federal Reserve Bank of St. Louis, issue Dec, pages 2-17.
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