Slow Recovery of Output after the 2007−09 Financial Crisis: U.S. Shortfall Spillovers and the U.K. Productivity Puzzle

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Abstract

Output in the U.S. and the U.K. recovered slowly following the 2007−09 financial crisis, even though unemployment rates returned to pre-crisis levels. To explain this mismatch, by using Okun’s law and a dynamic factor model to estimate the counterfactual recovery, we identify a change in regime in the aftermath of the financial crisis as the main determinant of the slow recovery. Additionally, by applying a trend-cycle decomposition, performed based on the difference version of Okun’s law, we distinguish between three driving forces of the slow recovery: declining trend growth began in the 1960s; unprecedented trend deceleration in U.S. potential output started during the 2007−09 financial crisis; and an unusually sluggish cyclical recovery known as hysteresis effects. Further, we develop an open-economy hierarchical dynamic factor model to demonstrate that spillovers of real activity shortfall from the U.S. explain at least half of the productivity puzzle in the U.K.
Original languageEnglish
Number of pages59
Publication statusSubmitted - 20 Nov 2023

Keywords

  • Slow Recovery
  • Productivity Puzzle
  • Trend-Cycle Decomposition
  • Okun’s Law
  • Dynamic Factor Model (DFM)
  • Structural Break
  • Open-economy Macroeconomics

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