To this end, the authors propose a model featuring endogenous productivity a la Romer and a liquidity friction a la Kiyotaki-Moore. A key finding in the authors’ study is that liquidity declined around the Lehman Brothers’ demise, which led to the severe contraction in the economy. This liquidity shock was a tail event. Improving conditions in financial markets were crucial in the subsequent recovery. Had conditions remained at their worst level in 2008, output would have been 20 percent below its actual level in 2011. The authors show that a subsidy to entrepreneurs would have gone a long way averting the crisis.
Liquidity, Trends, and the Great Recession
WP 14-24 - The authors study the impact that the liquidity crunch in 2008-2009 had on the U.S. economy’s growth trend.