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Engineering a paradox of thrift recession

Listed author(s):
  • Zhen Huo
  • José-Víctor Ríos-Rull

We build a variation of the neoclassical growth model in which financial shocks to households or wealth shocks (in the sense of wealth destruction) generate recessions. Two standard ingredients that are necessary are (1) the existence of adjustment costs that make the expansion of the tradable goods sector difficult and (2) the existence of some frictions in the labor market that prevent enormous reductions in real wages (Nash bargaining in Mortensen-Pissarides labor markets is enough). We pose a new ingredient that greatly magnifies the recession: a reduction in consumption expenditures reduces measured productivity, while technology is unchanged due to reduced utilization of production capacity. Our model provides a novel, quantitative theory of the current recessions in southern Europe.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta CQER Working Paper with number 2013-03.

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Date of creation: 2013
Handle: RePEc:fip:fedacq:2013-03
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  10. Pontus Rendahl, 2014. "Fiscal Policy in an Unemployment Crisis," Cambridge Working Papers in Economics 1456, Faculty of Economics, University of Cambridge.
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  18. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
  19. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
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