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Financial Conditions and Slow Recoveries

Kevin Huang (), Jie Chin (), Zhe Li () and Jianfei Sun
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Jie Chin: Shanghai University of Finance and Economics

No 14-00004, Vanderbilt University Department of Economics Working Papers from Vanderbilt University Department of Economics

Abstract: We argue that financial frictions and financial shocks can be an important factor behind the slow recoveries from the three most recent recessions. To illustrate this point, we augment a simple RBC model with a collateral constraint whose tightness is randomly disturbed by a shock that prescribes the general financial condition in the economy. We present evidence that such financial shock has become more persistent since the mid 1980s. We show that this can be an important contributor to the recent slow recoveries, and that a main mechanism may have to do with just-in-time-uses of capital and labor in the face of tight credit conditions during the recoveries. To assess the importance of such financial shock relative to other shocks in contributing to the slow recoveries, we enrich a New Keynesian model, which features various structural shocks and frictions widely considered in the literature, with the financial frictions and financial shocks studied in our parsimonious model. Our structural estimates of this comprehensive model indicate that financial shocks can play a dominant role in accounting for the slow recoveries, especially in employment growth rate.

Keywords: Collateral constraint; Financial shock; Slow recovery; Capital shortage; Extensive margin; Intensive margin (search for similar items in EconPapers)
JEL-codes: E2 E3 (search for similar items in EconPapers)
Date: 2014-06-06
New Economics Papers: this item is included in nep-dge and nep-mac
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