Financial Frictions, Financial Shocks, and Aggregate Volatility

54 Pages Posted: 16 Nov 2014

See all articles by Cristina Fuentes-Albero

Cristina Fuentes-Albero

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: January 2016

Abstract

I revisit the Great Inflation and the Great Moderation for nominal and real variables. I document an immoderation in corporate balance sheet variables so that the Great Moderation is best described as a period of divergent patterns in volatilities for real, nominal and financial variables. A model with time-varying financial frictions and financial shocks allowing for structural breaks in the size of shocks and the institutional framework is estimated. The paper shows that (i) while the Great Inflation was driven by bad luck, the Great Moderation was mostly due to better institutions; (ii) the slowdown in the volatility of credit spreads is driven by an easier access to credit, while a higher exposure to financial risk determines the immoderation of balance sheet variables; and (iii) the improvements in the institutional framework during the Great Moderation mitigate the effects of financial disturbances on the U.S. economy.

Keywords: Great Inflation, Great Moderation

JEL Classification: E32, E44, C11, C13

Suggested Citation

Fuentes-Albero, Cristina, Financial Frictions, Financial Shocks, and Aggregate Volatility (January 2016). FEDS Working Paper No. 2014-84, Available at SSRN: https://ssrn.com/abstract=2520178 or http://dx.doi.org/10.2139/ssrn.2520178

Cristina Fuentes-Albero (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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