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Expectations, Means-Tested Subsidies, and Economic Performance during the Recession

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Document pages: 36 pages

Abstract: The aggregate neoclassical growth model with only one impulse—means-tested subsidies whose replacement rates began rising at the end of 2007—produces time series for aggregate labor usage, consumption, investment, and real GDP that closely resemble actual US time series. Despite having no explicit financial market, the model has investment fall steeply during the recession not because of any distortions with the supply of capital, but merely because labor is falling and labor is complementary with capital in the production function. Through the lens of the model, the fact that real consumption fell significantly below trend during 2008 suggests that market participants were expecting labor usage to remain depressed for several years to come.

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