Shocks and Crashes

Martin Lettau, Sydney C. Ludvigson

Chapter in NBER book NBER Macroeconomics Annual 2013, Volume 28 (2014), Jonathan A. Parker and Michael Woodford, editors (p. 293 - 354)
Conference held April 12-13, 2013
Published in April 2014 by University of Chicago Press
© 2014 by the National Bureau of Economic Research
in NBER Book Series NBER Macroeconomics Annual

Three shocks, distinguished by whether their effects are permanent or transitory, are identified to characterize the post-war dynamics of aggregate consumer spending, labor earnings, and household wealth. The first shock accounts for virtually all of the variation in consumption; we argue that it can be plausibly interpreted as a permanent total factor productivity shock. The second shock, which underlies the vast bulk of quarterly fluctuations in labor income growth, permanently reallocates rewards between shareholders and workers but leaves consumption unaffected. Over the last 25 years, the cumulative effect of this shock has persistently boosted stock market wealth and persistently lowered labor earnings. We call this a factors share shock. The third shock is a persistent but transitory innovation that accounts for the vast majority of quarterly fluctuations in asset values but has a negligible impact on consumption and labor earnings at all horizons. We call this an exogenous risk aversion shock. We show that the 2000-02 asset market crash and recession surrounding it was characterized by a negative transitory wealth (positive risk aversion) shock, predominantly affecting stock market wealth. By contrast, the 2007-09 crash and recession was characterized by a string of large negative productivity shocks, as well as positive risk aversion shocks.

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This paper was revised on May 11, 2016

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Document Object Identifier (DOI): 10.1086/674605

This chapter first appeared as NBER working paper w16996, Shocks and Crashes, Martin Lettau, Sydney C. Ludvigson
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