- Assume that trend growth is 2.5%
- Then assume that we have an 18-month recession, during which growth averages -1%
- By the end of the recession, GDP is 7% lower than it would otherwise have been
- Growth then resumes
- Does it catch up with the trend again - as in chart 1 below - or not - as in chart 2?
- The recession is short enough not to significantly affect innovation and investment
- Growth depends on factors that are not (negatively) affected by recessions
- Underlying capacity growth will accelerate beyond trend as the recession ends
The theory behind the unit root empirical results remains murky. There are several mechanisms that might be working together. Innovation is one, as you suggest. Another is the impact on workers, who lose experience and job skills in downturns.