Stock and Watson
Disentangling the Channels of the 2007-2009 Recession
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Research Questions
• Beyond severity, how did this recession differ
from previous post-war recessions?
• What specific economic shocks triggered the
2007 recession and what were their
quantitative contributions?
• What is responsible for the anemic recovery in
output and employment?
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Approach
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Dynamic Factor Model
1959:Q1 – 2011:Q2
200 Macroeconomic variables
Six shocks
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Oil prices (3 instruments, taken from the literature)
Monetary policy (4)
Productivity (3)
Uncertainty (2)
Liquidity/Financial risk (3)
Fiscal policy (3)
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Answers
• There is little evidence of a new factor associated
with the 2007:Q4 recession and its aftermath.
Rather, the factors driving this recession are those
associated with previous recessions.
• The response to “old” factors seems to have been
the same post 2007:Q4 as pre 2007:Q4.
• The shocks to “old” factors were large, particularly in
fall 2008 (i.e., no need to bring in a special “financial
crisis” factor).
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Answers (2)
• Interpretation of 2007-09 recession:
– Economy was hit in close succession by a sequence of
unusually large shocks, all of which have been
experienced before, but not in such magnitude or
close succession.
– Specifically, an initial oil shock, followed by the
financial crisis, financial market disruptions and
prolonged uncertainty due to policy uncertainty.
 Financial crisis affected the economy through
uncertainty/liquidity and financial risk (i.e., traditional
channels, just larger shocks)
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Answers (3)
• Most of the slow recovery in employment and
nearly all the slow recovery in output is due to
a secular decline in trend labor force growth.
– Traceable to demographic factors
Plateau-ing of the historic increase in the female labor
force participation rate (1960-1990)
Somewhat smaller decline in male labor force
participation rate.
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Potential Explanations of Weak Recovery
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Tight monetary policy
Post-financial crisis hangover
Bad policy / policy uncertainty
Decline in growth of labor force
(demographic factors)
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