New York University
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New York, NY 10012
Information about this author at RePEc
NBER Working Papers and Publications
|November 2015||The Tail that Wags the Economy: Beliefs and Persistent Stagnation|
with Laura Veldkamp, Venky Venkateswaran: w21719
The Great Recession was a deep downturn with long-lasting effects on credit markets, labor markets and output. While narratives about what caused the recession abound, the persistence of GDP below its pre-crisis trend is puzzling. We propose a simple persistence mechanism that can be easily quantified and combined with existing models, even complex ones. Our solution rests on the premise that no one knows the true distribution of shocks to the economy. If agents use observed macro data to estimate this distribution non-parametrically, then transitory events, especially extreme events, generate persistent changes in beliefs and thus in macro outcomes. We apply our tool to an existing model, designed to explain the onset of the great recession, and find that adding belief updating endogenous...