Economists both failed to predict the global financial crisis and underestimated its consequences for the broader economy. Focusing on the second of these failures, this papers make two contributions. First, I review research since the crisis on the role of credit factors in the decisions of households, firms, and financial intermediaries and in macroeconomic modeling. This research provides broad support for the view that credit-market developments deserve greater attention from macroeconomists, not only for analyzing the economic effects of financial crises but in the study of ordinary business cycles as well. Second, I provide new evidence on the channels by which the recent financial crisis depressed economic activity in the United States. Although the deterioration of household balance sheets and the associated deleveraging likely contributed to the initial economic downturn and the slowness of the recovery, I find that the unusual severity of the Great Recession was due primarily to the panic in funding and securitization markets, which disrupted the supply of credit. This finding helps to justify the government’s extraordinary efforts to stem the panic in order to avoid greater damage to the real economy.
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