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  3. Journal of Economic Perspectives
  4. Summer 2018
  5. What Happened: Financial Factors in the Great Recession

What Happened: Financial Factors in the Great Recession

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Abstract

At the onset of the recent global financial crisis, the workhorse macroeconomic models assumed frictionless financial markets. These frameworks were thus not able to anticipate the crisis, nor to analyze how the disruption of credit markets changed what initially appeared like a mild downturn into the Great Recession. Since that time, an explosion of both theoretical and empirical research has investigated how the financial crisis emerged and how it was transmitted to the real sector. The goal of this paper is to describe what we have learned from this new research and how it can be used to understand what happened during the Great Recession. In the process, we also present some new empirical work. We argue that a complete description of the Great Recession must take account of the financial distress facing both households and banks and, as the crisis unfolded, nonfinancial firms as well. Exploiting both panel data and time series methods, we analyze the contribution of the house price decline, versus the banking distress indicator, to the overall decline in employment during the Great Recession. We confirm a common finding in the literature that the household balance sheet channel is important for regional variation in employment. However, we also find that the disruption in banking was central to the overall employment contraction.

Citation

Gertler, Mark, and Simon Gilchrist. 2018. "What Happened: Financial Factors in the Great Recession." Journal of Economic Perspectives, 32 (3): 3-30. DOI: 10.1257/jep.32.3.3

Additional Materials

JEL Classification

  • E23 Macroeconomics: Production
  • E24 Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
  • E32 Business Fluctuations; Cycles
  • E44 Financial Markets and the Macroeconomy
  • G01 Financial Crises
  • G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
  • R31 Housing Supply and Markets

A beautiful read

  • Posted by Stuart Parkinson
  • Posted on 8/7/2018 6:37:27 AM
This article is beautifully written and not particularly technical. It is rather amazing to think - as the authors point out in the opening paragraph - that the "workhorse macroeconomic models [of the early 2000s] assumed frictionless markets" which "were thus not able to anticipate the crisis", particularly when this period was in the direct aftermath of the bursting of the Dotcom bubble.

The authors also fail to mention near-zero short-term interest rates in the list of factors they say triggering the pre-Crash boom in borrowing, which I always think is odd in these kinds of reviews (imagine that: consumers being sensitive in their borrowing decisions to the nominal interest rate being charged). At least they aren't alone in this regard: almost nobody seems to mention it.

By the way, I can't believe there are so few comments (in fact, none) on this website about these articles. Perhaps the "post" button doesn't work... which we are about to find out.

Still a great article, though.
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