This paper considers the role of financial information in the estimation and dynamics of the US output gap over more than a century. To this end, we extend the parsimonious approach of Borio, Disyatat, and Juselius (2016, 2014) to allow for time-varying effects of financial factors. This novel feature significantly improves real-time estimates of the output gap. It signals the peak and trough in economic activity related to both the Great Recession and the Great Depression. Two major insights follow. Credit dynamics are the primary drivers of the observed financial crisis, albeit with different conduits over the century: the stock market in 1929 and the housing market in 2008. Accounting for credit growth, the US potential growth has been stable at 2% since the beginning of 1980.
JEL Codes: C11, C32, E32, O47.
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