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The Tail that Wags the Economy: Beliefs and Persistent Stagnation

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  • Kozlowski, Julian

    () (Federal Reserve Bank of St. Louis)

  • Veldkamp, Laura

    (Columbia University, Columbia Business School)

  • Venkateswaran, Venky

    (Federal Reserve Bank of Minneapolis)

Abstract

The Great Recession was a deep downturn with long-lasting effects on credit, employment and output. While narratives about its causes abound, the persistence of GDP below pre-crisis trends remains puzzling. We propose a simple persistence mechanism that can be quantified and combined with existing models. Our key premise is that agents don't know the true distribution of shocks, but use data to estimate it non-parametrically. Then, transitory events, especially extreme ones, generate persistent changes in beliefs and macro outcomes. Embedding this mechanism in a neoclassical model, we find that it endogenously generates persistent drops in economic activity after tail events.

Suggested Citation

  • Kozlowski, Julian & Veldkamp, Laura & Venkateswaran, Venky, 2019. "The Tail that Wags the Economy: Beliefs and Persistent Stagnation," Working Papers 2019-6, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2019-006
    DOI: 10.20955/wp.2019.006
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Robert Ulbricht & Ludwig Straub, 2015. "Endogenous Uncertainty and Credit Crunches," 2015 Meeting Papers 199, Society for Economic Dynamics.
    2. repec:eee:juecon:v:106:y:2018:i:c:p:81-100 is not listed on IDEAS
    3. Martin Guzman & Joseph E. Stiglitz, 2016. "Pseudo-wealth and Consumption Fluctuations," NBER Working Papers 22838, National Bureau of Economic Research, Inc.
    4. Jesus Fernandez-Villaverde & Lee Ohanian, 2018. "The Lack of European Productivity Growth: Causes and Lessons for the U.S," PIER Working Paper Archive 18-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 07 Sep 2018.
    5. repec:aea:jecper:v:31:y:2017:i:3:p:47-66 is not listed on IDEAS

    More about this item

    Keywords

    Stagnation; tail risk; propagation; belief-driven business cycles;

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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