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Federal Reserve Bank of Minneapolis
Economic Policy Paper
The Great Recession and Financial Shocks
Jose-Victor Rios-Rull
Zhen Huo
Abstract

A case can be made for the Great Recession being the result of a large financial shock that makes household borrowing difficult. The channel involves large reductions in house prices, which trigger sharp reductions in consumption.

We discuss the ingredients necessary for a quantitative macroeconomic model to successfully implement such a theory. They include: wealth heterogeneity, where the majority of the population needs to acquire financing to purchase houses despite the large amount of wealth in the economy; sizable real frictions that hinder the transformation of consumption into exports and investment and that constrain the increase of household working hours; and a role for expenditures in contributing to productivity.


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Jose-Victor Rios-Rull & Zhen Huo, The Great Recession and Financial Shocks, Federal Reserve Bank of Minneapolis, Economic Policy Paper 16-3, 09 Feb 2016.
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