Does risk matter more in recessions than in expansions? Implications for monetary policy

Martin M. Andreasen, Giovanni Caggiano, Efrem Castelnuovo*, Giovanni Pellegrino

*Corresponding author for this work

Research output: Contribution to journal/Conference contribution in journal/Contribution to newspaperJournal articleResearchpeer-review

Abstract

We employ a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences replicates these state-contingent responses when approximated to third order around its risky steady state due to a stronger upward nominal pricing bias in recessions than in expansions. Empirical evidence supports this state-contingent channel, and we show that it can greatly reduce the ability of systematic monetary policy to stabilize output during recessions.

Original languageEnglish
Article number103533
JournalJournal of Monetary Economics
Volume143
ISSN0304-3932
DOIs
Publication statusPublished - Apr 2024

Keywords

  • New Keynesian model
  • Non-recursive identification
  • Nonlinear SVAR
  • Risky steady state
  • State-contingent uncertainty shock

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