Accounting for the Great Recession in the UK: Real Business Cycles and Financial Frictions

Using the business cycle accounting (BCA) framework, we examine the 2008–9 recession in the UK. The recession appears to have been mostly driven by shocks to the efficiency wedge in total production, rather than intertemporal (asset price) consumption. From an expenditure perspective this result is consistent with the large observed falls in both consumption and investment. Simulated data from a dynamic stochastic general equilibrium (DSGE) model in which asset price shocks dominate finds no strong role for the intertemporal consumption wedge. This result implies that financial frictions work through more than just this channel.