Understanding the Aggregate Effects of Credit Frictions and Uncertainty

Abstract

This paper integrates a financial accelerator mechanism à la Bernanke et al. (1999) and timevarying uncertainty into a Dynamic New Keynesian model. We examine the extent to which uncertainty and credit conditions interact with one another. The idea is that uncertainty aggravates the information asymmetry between lenders and borrowers, and worsens credit conditions. Already poor credit conditions amplify the effect of shocks (to both the mean and variance) on the aggregate economy. In our model, uncertainty modelled as time-varying stochastic volatility emerges from monetary policy (policy uncertainty), financial risks (microuncertainty), and the aggregate state of the economy (macro-uncertainty). Using a third order approximation, we find that micro-uncertainty has first order effects on economic activity through its direct impact on credit conditions. We also find that if credit conditions (as measured by the endogenous risk spread) are already poor, then additional micro-uncertainty shocks have even larger real effects. In turn, shocks to aggregate uncertainty (macro-and policy-uncertainty) have relatively small direct effects on aggregate economic activity.

Uncertainty, Financial Frictions, and Nominal Rigidities: A Quantitative Investigation

“…Chugh () finds a value of 0.037. Finally, Balke, Martinez‐Garcia, and Zeng (), who estimate via simulated method moments using aggregate macrofinancial data, find a value of 0.025. Despite the different data and sample period used in different studies, our estimates are close to those found elsewhere in the literature.…”

“…Finally, Bloom (), Bloom et al. (), Bachmann and Bayer (), and Balke, Martinez‐Garcia, and Zeng () consider both notions of uncertainty.…”

“…). While writing this paper we became aware of a paper by Balke, Martinez‐Garcia, and Zeng () who also consider both micro‐ and macro‐uncertainty in a set up similar to ours. The key difference lies in the estimation of the time‐series properties of micro‐uncertainty, as we explain in more detail below.…”

“…In a similar spirit, Balke, Martinez‐Garcia, and Zeng () estimate their model with the simulated method of moments.…”