Financial shocks and the US business cycle

Employing the financial accelerator (FA) model of Bernanke et al. [1999. The Financial accelerator in a quantitative business cycle framework. In: Taylor, J.B., Woodford, M. (Eds.), Handbook of Macroeconomics, vol. 1C. Handbooks in Economics, vol. 15. Elsevier, Amsterdam, pp. 1341–1393] enhanced to include a shock to the FA mechanism, we construct and study shocks to the efficiency of the financial sector during post-war US business cycles. These shocks are found to (i) be very tightly linked with the onset of recessions, more so than TFP or monetary shocks; (ii) remain contractionary after recessions have ended; (iii) account for a large part of the variance of GDP; (iv) be generally much more important than money shocks and (v) be strongly negatively correlated with the external finance premium.