The Tail that Wags the Economy: Beliefs and Persistent Stagnation

61 Pages Posted: 16 Nov 2015 Last revised: 7 May 2021

See all articles by Julian Kozlowski

Julian Kozlowski

New York University (NYU)

Laura Veldkamp

Columbia University - Columbia Business School; National Bureau of Economic Research (NBER)

Venky Venkateswaran

Federal Reserve Banks - Federal Reserve Bank of Minneapolis; New York University (NYU) - Leonard N. Stern School of Business

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Date Written: November 2015

Abstract

The Great Recession was a deep downturn with long-lasting effects on credit, employment and output. While narratives about its causes abound, the persistence of GDP below pre-crisis trends remains puzzling. We propose a simple persistence mechanism that can be quantfied and combined with existing models. Our key premise is that agents don't know the true distribution of shocks, but use data to estimate it non-parametrically. Then, transitory events, especially extreme ones, generate persistent changes in beliefs and macro outcomes. Embedding this mechanism in a neoclassical model, we find that it endogenously generates persistent drops in economic activity after tail events.

Suggested Citation

Kozlowski, Julian and Veldkamp, Laura and Venkateswaran, Venky and Venkateswaran, Venky, The Tail that Wags the Economy: Beliefs and Persistent Stagnation (November 2015). NBER Working Paper No. w21719, Available at SSRN: https://ssrn.com/abstract=2691237

Julian Kozlowski (Contact Author)

New York University (NYU) ( email )

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Laura Veldkamp

Columbia University - Columbia Business School ( email )

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National Bureau of Economic Research (NBER)

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Venky Venkateswaran

New York University (NYU) - Leonard N. Stern School of Business ( email )

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