Understanding the Aggregate Effects of Credit Frictions and Uncertainty: 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 our simulation and estimation approach. We use this framework to identify how uncertainty propagates and its interplay with financial frictions. We also investigate how uncertainty affects the propagation of other shocks (in particular, the propagation of TFP and monetary policy shocks).

Understanding the Aggregate Effects of Credit Frictions and Uncertainty

“…6 Additional details on the model solution and the simulation and estimation methods together with a rich set of supplementary results can be found in Balke et al (2017). 7 We build on Bernanke and Gertler (1989), Bernanke et al (1999), Cohen-Cole and Martínez-García (2010), Martínez-García (2014), and Christiano et al (2014), among others, to incorporate risky debt and (b) shocks to the cross-sectional dispersion of the idiosyncratic productivity shocks (microuncertainty) together with time-varying uncertainty in TFP (macro-uncertainty) and monetary policy (policy uncertainty).…”

“…28 Balke et al (2017) (Figures 12 to 13) provide the joint distribution of the credit spread against other economically-relevant variables of the model as well. a positive monetary policy shock when monetary policy uncertainty is initially high almost triples that which we observe when …nancial conditions are poor (high spreads).…”

“…Note: E(:) denotes unconditional mean, VAR(:) denotes unconditional variance, and (:) denotes the …rst-order autocorrelation. More details on the data sources can be found in Balke et al (2017). Note: The endogenous variables included are output, household consumption, investment, hours worked by households, real wages, in ‡ation, and nominal interest rates.…”

“…Using mean-preserving volatility shocks allows us to cleanly disentangle the e¤ect of …rst moment and second moment shocks. SeeBalke et al (2017) for a detailed description of our approach.…”

“…Balke et al (2017) (Figure 11) compares the average impulse responses over the unconditional distribution of initial conditions with the impulse response with an initial condition equal to the unconditional mean. The two sets of responses are qualitatively similar, but the average response to interest rate shocks is larger in magnitude than the corresponding response starting at the unconditional mean.…”