Do large recessions reduce output permanently?
The slow recovery following the 2008/2009 recession has led to renewed interest in the question
whether deep recessions lower real GDP permanently or whether we can expect a rebound to earlier
trend levels. Using a recent quantile autoregression unit root test we check whether shocks to real
GDP have permanent or temporary effects. In contrast to earlier studies this approach takes into
account that the transmission of a shock might depend on the sign and the size of the shock. Large
recessionary shocks might have a different effect than smaller recessionary or expansionary shocks.
We do not only test the unit root hypothesis at the conditional mean of GDP, but also in the tails of the
distribution where the lower tail corresponds to large recessions. The test has more power than
conventional unit root tests. We find that positive and negative shocks including large recessionary
shocks have permanent effects on output. Therefore, a rebound of GDP to its pre-crisis trend level is
unlikely. Current output gap estimates based on deterministic trends are likely to be too negative and
inflation forecasts based on these are likely to be too low.