The Post-Crisis Slump in the Euro Area (EA) and the US: Evidence From an Estimated Three-Region DSGE Model (European Economic Review, 2016, Vol.88, pp. 21-41) Robert Kollmann1,2; Beatrice Pataracchia3; Rafal Raciborski4; Marco Ratto3; Werner Roeger4; Lukas Vogel4 1Université Libre de Bruxelles; 2CEPR; 3European Commission, JRC; 4European Commission, DG-ECFIN Contact: robert_kollmann@yahoo.com, www.robertkollmann.com Historical Decomposition: EA GDP growth (y-o-y) Abstract ●Global financial crisis (2008-09) led to sharp contraction in Euro Area (EA) and US real activity, and was followed by long-lasting slump ● Striking post-crisis differences between EA & US: EA slump markedly more protracted ● We estimate a 3-region model (EA, US, Rest of World), 1999q1-2014q4, to quantify the drivers of the divergent EA and US adjustment paths ●Before crisis: EA investment boom ●2008-2009: - EA investment risk premium  - EA TFP  - Negative trade shocks ●2010: Recovery, EA risk premium  ●After 2010: -EA risk premium  (sovereign debt crisis) - Less important: Fiscal policy Price and wage markup shocks Household saving shocks Euro risk premium Euro Area & US Macroecon. & Financial Conditions ►More persistent fall in EA GDP & TFP growth ►EA employment rate remains low ►EA Investment/GDP ratio trends down ►Inflation lower in EA than in US Bank health after 2010: worsens in EA, improves in US ►Rise in EA non-performing loans ►EA credit continues to tighten Historical Decomposition: US GDP growth (y-o-y) ●Pre-crisis boom: low investment risk premium was key driver ● 2008-2009: - US investment risk premium  - Saving shocks - Price mark-up shocks; monetary policy; Rest-of-World (ROW) shocks ● After 2010: - Investment risk premium normalizes in US Conclusion ►Financial shocks were key drivers of the 2008-09 Great Recession, in EA and US ►EA post-crisis slump: combination of adverse supply and demand shocks ● Negative TFP shocks ● Negative investment shocks, linked to persistent weakness of EA banks   ►Adverse financial shocks less persistent in US ►Fiscal policy (austerity) not key for EA slump ► Low post-crisis EA inflation: largely driven by fall in markups (and by weak aggregate demand)   Research Method ESTIMATED 3-region DSGE model (EA, US, Rest-of-World) ► EA & US blocks: same structure (very detailed) ► 58 shocks, 53 observables ► Nominal & real rigidities ► Financially constrained & unconstrained households ► Distorting taxes, government debt ► Investment risk premium shocks: exogenous investment wedges (capture intermediation frictions and/or bubbles) Impulse Responses Positive permanent EA TFP shock Persistent fall in TFP: ●Triggers persistent fall in GDP & I ●But can’t explain fall in inflation & I/Y ●Can’t explain EA TB improvement This shock alone cannot explain data; need combination of shocks Positive EA invest. risk premium shock ● Lowers Y, I/Y and Labor (persistently) ● But: C is crowded in by this shock Related Literature There is little other model-based empirical work on EA post-crisis slump Prominent views about sources of persistent slump: ►Restrictive fiscal policy (austerity): e.g. De Grauwe (2014), Stiglitz (2015) We find: fiscal policy had minor influence ►Financial constraints for investors: e.g. Kalemli-Özcan et al. (2015) Consistent with our findings ►Rigidities in product & labor markets: e.g. Fernald (2015). We find: rigidities explain EA vs. US differences in price & wage adjustment + post-crisis rise in EA wage share ►Other estimated DSGE studies on US post-crisis slump use closed economy models: Christiano et al. (2015), Fratto and Uhlig (2015), Lindé et al. (2015), Del Negro et al. (2015). We use open economy model & find significant role for foreign shocks