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Switching-track after the Great Recession

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  • Francesca Vinci
  • Omar Licandro

Abstract

Data suggests that the level of GDP shifted to a permanently lower trend following the Great Recession for most advanced countries, and researchers have not yet reached a consensus concerning the drivers of this phenomenon. We contribute to this literature by suggesting a DSGE model with financial frictions and endogenous growth through learning-by-doing. With an aggregate AK technology, a negative shock to the capital stock has the effect of moving the economy to a lower trend. A Taylor rule policy designed to reduce the output gap may counterbalance the shock, bringing the economy back to the past trend. However, when the recession is deep and persistent and the ZLB binds, a revision of potential output measures may weaken the recovering role of monetary policy, making the economy converge to a lower trend. We calibrate the model to the U.S. economy and find that GDP can fully recover from a textbook TFP shock under a standard Taylor rule, whilst large demand shocks can affect the supply side permanently. Our framework is thus consistent with episodes of economic recovery as well as episodes of no-recovery. Results rely on the observation that the measurement of U.S. potential output switched track as the Great Recession unfolded, because the severe and prolonged slump put downward pressure on estimates. As a consequence, the output gap closed following the switching-track of potential output, rather than faster GDP growth.

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  • Francesca Vinci & Omar Licandro, 2020. "Switching-track after the Great Recession," Discussion Papers 2020/02, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  • Handle: RePEc:not:notcfc:2020/02
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    Cited by:

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    2. Fornaro, Luca & Wolf, Martin, 2020. "The Scars of Supply Shocks," CEPR Discussion Papers 15423, C.E.P.R. Discussion Papers.
    3. Antonio Fatás & Sanjay R. Singh, 2022. "Supply or Demand? Policy Makers' Confusion in the Presence of Hysteresis," Working Papers 347, University of California, Davis, Department of Economics.
    4. Cristiana Benedetti-Fasil & Giammario Impullitti & Omar Licandro & Petr Sedlacek, 2021. "Heterogeneous Firms, R&D Policies and the Long Shadow of Business Cycles," JRC Working Papers on Territorial Modelling and Analysis 2021-04, Joint Research Centre (Seville site).
    5. Omar Licandro & Francesca Vinci, 2021. "Potential output, the Taylor Rule and the Fed," Discussion Papers 2021/03, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    6. Bianca Barbaro & Giorgio Massari & Patrizio Tirelli, 2022. "Who killed business dynamism in the U.S.?," Working Papers 494, University of Milano-Bicocca, Department of Economics, revised Mar 2022.
    7. Matteo Cacciatore & Dmitry Matveev & Rodrigo Sekkel, 2022. "Uncertainty and Monetary Policy Experimentation: Empirical Challenges and Insights from Academic Literature," Discussion Papers 2022-9, Bank of Canada.

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    More about this item

    Keywords

    Great Recession; Economic Recovery; Endogenous Growth; Hysteresis; Trend Shift; Switching-track;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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