Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model

Francesco Lucidi and Willi Semmler

Journal of Macroeconomics, 2023, vol. 75, issue C

Abstract: We build a small-scale nonlinear quadratic (NLQ) model in which credit feedback and regime switches in the output gap affect the adjustment path of the economy towards a steady state. The central bank solves a finite-horizon decision problem where the policy rate also can be zero or negative. We estimate this model by nonlinear seemingly unrelated regression method (NLSUR) and using the parameters to explore policy scenarios. The latter projects long-run dynamics after a large demand contraction leading to scarring effects on the economy. We point out three main results. First, while scars are dominant when the central bank follows a standard Taylor rule, unconventional monetary policy (UMP) – such as Quantitative Easing – mitigates the output decline in both the short and the long run. Second, a zero natural interest rate curtails the central bank’s ability to adjust the economy and mitigate scars. Third, financial constraints leave the deepest scars even if UMP is active.

Keywords: Nonlinear quadratic model; Credit feedback; Unconventional monetary policy; Scarring effects (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:75:y:2023:i:c:s0164070422000805

DOI: 10.1016/j.jmacro.2022.103487

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