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

Abstract

We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. The model considers credit frictions arising from costly-state verification in the provision of loans to fund the acquisition of capital by entrepreneurs and includes three types of time-varying stochastic volatility shocks related to monetary policy uncertainty, financial risk (micro-uncertainty), and macro-uncertainty. Key parameters are estimated by the Simulated Method of Moments using U.S. data from 1984:Q1 until 2014:Q4. We find: 1. Micro-uncertainty has first-order effects that are significantly larger than the effects of macro-uncertainty and monetary policy uncertainty. 2. Poor credit conditions exacerbate the economic drag from micro-uncertainty shocks, amplify the effects of monetary policy shocks, and mitigate the impact of TFP shocks. 3. A degree of asymmetry and non-scalability appears in response to monetary policy shocks, dependent on the degree of nominal rigidities and initial conditions. 4. Monetary policy uncertainty accounts for about one-third of the business cycle volatility largely by affecting the size of monetary policy shocks.

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

“…given that I t is known at time t and can be taken out of the expectation. For convenience, in Balke et al (2017), equation 33is alternatively re-written in terms of the equity ratio,…”

“…We also present an overview of the data used to estimate the model as well as a detailed explanation of the codes developed for the estimation and for the quantitative simulation of the pruned third-order approximation of the model's solution. Finally, this paper also contains a further discussion of the main results obtained from the estimated model as well 1 as a comprehensive set of experiments not reported in Balke et al (2017) but conducted in order to establish the robustness of our …ndings.…”

“…The framework of Balke et al (2017) employs a medium-scale Dynamic New Keynesian model with credit frictions (asymmetric information and costly monitoring as in Bernanke et al (1999)) and uncertainty (stochastic volatility as in Fernández-Villaverde et al (2010)). In Balke et al (2017), we study speci…cally how …nancial frictions and micro-uncertainty a¤ect our understanding of the monetary policy transmission mechanism through the lens of the Dynamic New Keynesian model. We also investigate the interaction between credit frictions and macro/policy uncertainty and micro-uncertainty explicitly.…”

“…We also investigate the interaction between credit frictions and macro/policy uncertainty and micro-uncertainty explicitly. This is where the estimated model of Balke et al (2017) makes its most novel quantitative contributions.…”

“…This paper is intended to complement the work of Balke et al (2017). We describe our approach to model mean-preserving stochastic volatility in detail, provide a derivation of the optimal nominal risky debt contract between entrepreneurs (borrowers) and …nancial intermediaries (lenders), and include a brief description of the equilibrium conditions and steady state equations that characterize the solution of the Balke et al (2017) model. We also present an overview of the data used to estimate the model as well as a detailed explanation of the codes developed for the estimation and for the quantitative simulation of the pruned third-order approximation of the model's solution.…”