Financial Intermediation, House Prices and the Welfare Effects of the U.S. Great Recession

This paper quantifies the welfare costs of the Great Recession in the United States and their distribution between borrowing and saving households. We use a calibrated dynamic general equilibrium model with shocks to aggregate income and to the financial intermediation sector. The model matches the boom-bust cycle in house prices, the dynamics of household leverage, and the increase in inequality of wealth observed in the U.S. after 2007. We find large welfare costs for financially constrained households, the borrowers. Savers instead benefited from a redistribution of housing wealth due to the de-leveraging of borrowers caused by the plunge in house prices. This redistribution mechanism was exacerbated by the financial intermediation shock. We also show that the welfare costs for borrowers would have been lower if aggregate leverage had remained at pre-2001 levels.