In No Uncertain Terms: The Effect of Uncertainty on Credit Frictions and Monetary Policy Supplementary Materials and Additional Results

Abstract

Balke et al. (2017)'s model integrates financial frictions-arising from asymmetric information and costly monitoring-and time-varying uncertainty into a medium-scale Dynamic New Keynesian model. The model includes monetary policy uncertainty, financial risks (micro-uncertainty), and aggregate macro-uncertainty in stochastic volatility form. In this paper, we provide the key derivations of the model as well as detailed information on the simulation and estimation approach employed. We use this modeling framework to thoroughly explore how uncertainty propagates and its interplay with financial frictions. We also investigate further how uncertainty affects the propagation of first-moment shocks (TFP and monetary policy shocks) and second-moment shocks with first-order effects (micro-uncertainty).

In No Uncertain Terms: The Effect of Uncertainty on Credit Frictions and Monetary Policy

“…Our approach keeps the stochastic processes in logs, ensures they are non-negative in levels, and also prevents second-moment shocks from having an impact on …rst-moments to cleanly isolate one from the other. See the Appendix and Balke et al (2017b) for the technical details of our novel recursive approach to modeling mean-preserving stochastic volatility.…”

“…12 Section 3 in Balke et al (2017b) provides a detailed derivation of the optimal one-period nominal loan contract in (10) (11) and a formal derivation of the functions f (! 1 if = 0.…”

“…We extract the cyclical component of all these series by HP-…ltering them with a one-sided …lter using a lambda of 1600 and a power of 2, except for the equity ratio and the nominal interest rate that are demeaned instead. More details on the data sources can be found in Balke et al (2017b). The table shows the standard deviation of output and the standard deviation of all other endogenous variables relative to the standard deviation of output.…”

“…In fact, when examining the importance of stochastic volatility shocks, the existing literature often focuses on the response to a 28 A number of papers-such as Cesa-Bianchi and Fernández-Corugedo (2018)-the literature conduct their analysis calculating responses conditional on the ergodic (unconditional) mean instead of averaging impulse responses over the unconditional distribution of initial conditions, as we do in Figure 1. Balke et al (2017b) (Figure 5) illustrates the impulse responses corresponding to Figure 1 under this alternative approach setting the initial condition to be equal to the ergodic (unconditional) mean. The two sets of responses are qualitatively similar, although the average response to …rst-moment shocks (monetary policy shocks and TFP shocks) is larger in magnitude than the corresponding response starting at the ergodic (unconditional) mean.…”

“…39 The responses of output, the credit spread, and the nominal interest rate to TFP, micro-uncertainty, and monetary policy shocks conditional on other uncertainty types except their own are very similar whether those other uncertainty types are high (95 th percentile) or low (5 th percentile). Further details on that can be found in Balke et al (2017b) (see, e.g., Figures 1, 6, and 10). also …nd in Figure 7 that the output response to TFP shocks and monetary policy shocks is larger when their own uncertainty is high, primarily for the obvious reason that a high level of their own uncertainty means the size of the shocks is larger too.…”