EconPapers    
Economics at your fingertips  
 

Risk and State-Dependent Financial Frictions

Martin Harding and Rafael Wouters

Staff Working Papers from Bank of Canada

Abstract: We augment a standard New Keynesian model with a financial accelerator mechanism and show that financial frictions generate large state-dependent amplification effects. We fit the model to US data and show that show that, when shocks drive the model far away from the steady state, the nonlinear model produces much stronger propagation of shocks than the linearized model. We document that these amplification effects are due to endogenous variation in financial conditions and not due to other nonlinearities in the model. Motivated by these findings, we propose a regime-switching dynamic stochastic general equilibrium framework where financial frictions endogenously fluctuate between moderate (low risk) and severe (high risk), depending on the state of the economy. This framework allows for efficient estimation with many state variables and improves fit with respect to the linear model.

Keywords: Central bank research; Credit and credit aggregates; Financial stability; Monetary policy (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2022-08
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-fdg and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
https://www.bankofcanada.ca/wp-content/uploads/2022/08/swp2022-37.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:22-37

Access Statistics for this paper

More papers in Staff Working Papers from Bank of Canada 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada. Contact information at EDIRC.
Bibliographic data for series maintained by ().

 
Page updated 2024-03-01
Handle: RePEc:bca:bocawp:22-37