Financial Cyclical Factors and Growth : Insights from an Augmented Stochastic Solow Growth Model

We present an augmented stochastic version of the Solow neoclassical growth model to examine whether financial factors -- expressed as deviations from their trend -- represent important business cycle drivers.Our novel framework is used to study the dynamics of the US growth over the period 1890-2013. We find that financial cyclical factors played an important role in explaining output fluctuations in the US over the last century. By comparing different model specifications, we show that the role of each specific financial factor in explaining growth changes over time generating model's instability. Taken together, our results have implications for the effectiveness of medium-term policy interventions.Accounting for such cyclical factors is thus relevant for policymakers