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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. Roger Farmer & Dmitry Plotnikov, 2012. "Does Fiscal Policy Matter? Blinder and Solow Revisited," 2012 Meeting Papers 73, Society for Economic Dynamics.
  2. 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.
  3. Jean-Paul Fitoussi & David Jestaz & Edmund S. Phelps & Gylfi Zoega, 2000. "Roots of the Recent Recoveries: Labor Reforms or Private Sector Forces?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(1), pages 237-311.
  4. Farmer, Roger E A, 2010. "Animal Spirits, Persistent Unemployment and the Belief Function," CEPR Discussion Papers 8100, C.E.P.R. Discussion Papers.
  5. Paul Gomme & B. Ravikumar & Peter Rupert, 2006. "The return to capital and the business cycle," Working Paper 0603, Federal Reserve Bank of Cleveland.
  6. 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.
  7. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  8. 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.
  9. 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.
  10. Farmer, Roger, 2010. "Expectations, Employment and Prices," OUP Catalogue, Oxford University Press, number 9780195397901, March.
  11. Beyer, Andreas & Farmer, Roger E. A., 2003. "Identifying the monetary transmission mechanism using structural breaks," Working Paper Series 0275, European Central Bank.
  12. 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.
  13. 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.
  14. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  15. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  16. Roger E.A. Farmer, 2009. "Confidence, Crashes and Animal Spirits," NBER Working Papers 14846, National Bureau of Economic Research, Inc.
  17. Farmer, Roger, 2010. "How the Economy Works: Confidence, Crashes, and Self-Fulfilling Prophecies," OUP Catalogue, Oxford University Press, number 9780195397918, March.
  18. 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.
  19. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper 2004-14, Federal Reserve Bank of Atlanta.
  20. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, October.
  21. Farmer, Roger E A, 2000. "Natural Rate Doubts," CEPR Discussion Papers 2426, C.E.P.R. Discussion Papers.
  22. Roger E.A. Farmer (ed.), 2008. "Macroeconomics in the Small and the Large," Books, Edward Elgar, number 13236.
  23. Olivier J. Blanchard, 1986. "Hysteresis and Unemployment," Working papers 430, Massachusetts Institute of Technology (MIT), Department of Economics.
  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. 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.
  27. 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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