The Tail that Wags the Economy: Beliefs and Persistent Stagnation

Laura Veldkamp and Venky Venkateswaran
Authors registered in the RePEc Author Service: Julian Kozlowski

No 11352, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Stagnation; Tail risk; Propagation; Belief-driven business cycles (search for similar items in EconPapers)
JEL-codes: D84 E32 (search for similar items in EconPapers)
Date: 2018-10
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (26)

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Related works:
Working Paper: The Tail that Wags the Economy: Beliefs and Persistent Stagnation (2019)
Working Paper: The Tail that Wags the Economy: Beliefs and Persistent Stagnation (2015)
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