Shocks and crashes

Martin Lettau, Sydney C. Ludvigson

    Research output: Contribution to journalArticlepeer-review


    Three shocks, distinguished by whether their effects are permanent or transitory, are identified to characterize the postwar dynamics of aggregate consumer spending, labor earnings, and household wealth. The first shock accounts for virtually all of the variation in consumption; we argue that it can be plausibly interpreted as a permanent total factor productivity shock. The second shock, which underlies the vast bulk of quarterly fluctuations in labor income growth, permanently reallocates rewards between shareholders and workers but leaves consumption unaffected. Over the last twenty- five years, the cumulative effect of this shock has persistently boosted stock market wealth and persistently lowered labor earnings. We call this a factor share shock. The third shock is a persistent but transitory innovation that accounts for the vast majority of quarterly fluctuations in asset values but has a negligible impact on consumption and labor earnings at all horizons. We call this an exogenous risk aversion shock. We show that the 2000 to 2002 asset market crash and recession surrounding it was characterized by a negative transitory wealth (positive risk aversion) shock, predominantly affecting stock market wealth. By contrast, the 2007 to 2009 crash and recession was characterized by a string of large negative productivity shocks, as well as positive risk aversion shocks.

    Original languageEnglish (US)
    Pages (from-to)293-354
    Number of pages62
    JournalNBER Macroeconomics Annual
    Issue number1
    StatePublished - 2013

    ASJC Scopus subject areas

    • Economics and Econometrics


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