Discussion paper
DP11544 Financial Frictions, Asset Prices, and the Great Recession
We study financial shocks to households’ ability to borrow in an economy that quantitatively replicates U.S.
earnings, financial, and housing wealth distributions and the main macro aggregates. Such shocks generate
large recessions via the negative wealth effect associated with the large drop in house prices triggered by the
reduced access to credit of a large number of households. The model incorporates additional margins that are
crucial for a large recession to occur: that it is difficult to reallocate production from consumption to investment
or net exports, and that the reductions in consumption contribute to reductions in measured TFP.
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