Understanding the Aggregate Effects of Credit Frictions and Uncertainty

Nathan Balke, Enrique Martínez García (emg.economics@gmail.com) and Zheng Zeng

No 317, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. To do so, uncertainty is modeled as time-varying stochastic volatitlity - the product of monetary policy uncertainty, financial risk (micro-uncertainty), and macrouncertainty. The model is solved using a pruned third-order approximation and estimated by the Simulated Method of Moments. We find that: 1) Micro-uncertainty aggravates the information asymmetry between lenders and borrowers, worsens credit conditions, and has first-order effects on real economic activity. 2) When credit conditions are poor, as indicated by elevated credit spreads, additional micro-uncertainty shocks produce even larger real effects. 3) Poor credit conditions notably affect the transmission mechanism of monetary policy amplifying the real effects of monetary shocks while mitigating the economic boost from TFP shocks. 4) While macro-uncertainty and policy uncertainty exert relatively little direct impact on aggregate economic activity, policy uncertainty accounts for around 40% of the business cycle volatility by affecting the size of monetary policy shocks in the presence of nominal rigidities.

Keywords: Financial Accelerator; Stochastic Volatility; Monetary Policy Transmission; Nominal Rigidities; Perturbation Methods (search for similar items in EconPapers)
JEL-codes: C32 D8 E32 E44 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2017-06-20
New Economics Papers: this item is included in nep-dge and nep-mac
Note: Original paper and supplement were published in June 2017. Revised paper and supplement were published in October 2019.
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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https://www.dallasfed.org/-/media/documents/institute/wpapers/2017/0317r1.pdf Revised paper (application/pdf)
https://www.dallasfed.org/-/media/documents/institute/wpapers/2017/0317ar1.pdf Revised supplement (application/pdf)
https://www.dallasfed.org/~/media/documents/institute/wpapers/2017/0317.pdf Original paper (application/pdf)
https://www.dallasfed.org/~/media/documents/institute/wpapers/2017/0317a.pdf Original supplement (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:317

DOI: 10.24149/gwp317r1

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