Liquidity, Trends, and the Great Recession

We study the impact that the liquidity crunch in 2008-2009 had on the U.S. economys growth trend. To this end, we propose a model featuring endogenous productivity á la Romer and a liquidity friction á la Kiyotaki-Moore. A key \u85nding in our study is that liquidity declined around the Lehman Brothersdemise, which led to the severe contraction in the economy. This liquidity shock was a tail event. Improving conditions in \u85nancial markets were crucial in the subsequent recovery. Had conditions remained at their worst level in 2008, output would have been 20 percent below its actual level in 2011. We show that a subsidy to entrepreneurs would have gone a long way averting the crisis.