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Engineering a paradox of thrift recession

  • Zhen Huo
  • Jose-Victor Rios-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 Minneapolis in its series Staff Report with number 478.

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Date of creation: 2012
Date of revision:
Handle: RePEc:fip:fedmsr:478
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  18. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
  19. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
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