Engineering a Paradox of Thrift Recession

We build a variation of the neoclassical growth model in which nancial shocks to households or wealth shocks (in the sense of wealth destruction) generate recessions. Two standard ingredients that are necessary are (1) the existence of adjustment costs that make the expansion of the tradable goods sector di cult and (2) the existence of some frictions in the labor market that prevent enormous reductions in real wages (Nash bargaining in Mortensen-Pissarides labor markets is enough). We pose a new ingredient that greatly magni es the recession: a reduction in consumption expenditures reduces measured productivity, while technology is unchanged due to reduced utilization of production capacity. Our model provides a novel, quantitative theory of the current recessions in southern Europe.