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The Anatomy of Stagnation in a Modern Economy

Economica / NEW SERIES

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In 2008, the worst financial crisis since the Great Depression launched a deep contraction of the US economy. Output fell quickly to a level 10% below trend. Unemployment reached 10% of the labour force. Seven years after the crisis, unemployment was back to normal, but output was 15% below trend. Stagnation had set in. The most important source of the stagnation was a sharp decline in productivity growth. A decline in R&D and other productivity‐enhancing investment was at least partially responsible. That decline began before the crisis, but the financial events of 2008 worsened the cutback. A second major source of stagnated output and income was capital depletion. Investment in business equipment fell in half immediately after the crisis. Cumulatively, the effect of below‐trend investment accounted for 5 of the 15 percentage points of the shortfall in output. The third major development accounting for stagnation in output was a decline in the labour force that remained after unemployment had returned to normal. This development accounted for more than 3 percentage points of the shortfall in output. As a general matter, the direct decline in labour input and in output associated with the rise in unemployment was not important by 2015, but the follow‐on stagnation operating through the effects on the two types of capital formation was substantial.