Accounting for the role of investment frictions in recessions

Abstract

Our business cycle accounting exercise reveals that both capital and investment efficiency declines played a prominent role in accounting for the output downturn during the US Great Recession. The evidence indicates that an increase in firms' investment costs may have played a substantial role during the US Great Recession, consistent with business cycle models in which firms face financial frictions. The negligible role played by the total factor productivity decline in accounting for the output downturn during the US Great Recession found by previous works can be explained by the movement in opposite directions of both labour and capital efficiency. However, we find that labour efficiency falling was the main force driving output downturn in the 1982 recession and the euro area Great Recession