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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
Understanding the Great Recession
Lawrence J. Christiano
Martin Eichenbaum
Mathias Trabandt
Abstract

We argue that the vast bulk of movements in aggregate real economic activity during the Great Recession were due to financial frictions interacting with the zero lower bound. We reach this conclusion looking through the lens of a New Keynesian model in which firms face moderate degrees of price rigidities and no nominal rigidities in the wage setting process. Our model does a good job of accounting for the joint behavior of labor and goods markets, as well as inflation, during the Great Recession. According to the model the observed fall in total factor productivity and the rise in the cost of working capital played critical roles in accounting for the small size of the drop in inflation that occurred during the Great Recession.


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Lawrence J. Christiano & Martin Eichenbaum & Mathias Trabandt, Understanding the Great Recession, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1107, 02 Apr 2014.
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Keywords: Inflation; unemployment; labor force; zero lower bound
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