Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model

26 Pages Posted: 16 Aug 2019 Last revised: 22 Feb 2022

See all articles by Francesco Simone Lucidi

Francesco Simone Lucidi

University of Naples Federico II

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Date Written: February 21, 2022

Abstract

We build a small-scale nonlinear quadratic (NLQ) model in which credit feedback and regime switches in the output gap affect the adjustment path of the economy towards a steady state. The central bank solves a finite-horizon decision problem where the policy rate also can be zero or negative. We estimate this model by nonlinear seemingly unrelated regression method (NLSUR) and using the parameters to explore policy scenarios. The latter projects long-run dynamics after a large demand contraction leading to scarring effects in the economy. We point out three main results. First, while scars are dominant when the central bank follows a standard Taylor rule, unconventional monetary policy (UMP) mitigates the output decline in both the short and the long run. Second, a zero natural rate of interest alone curtails the central bank's ability to adjust the economy. Third, financial constraints leave the deepest scars even if UMP is active.

Keywords: credit cycles, credit spread, inflation targeting, nonlinear Phillips curve, unconventional monetary policy

JEL Classification: E42, E52, E58

Suggested Citation

Lucidi, Francesco Simone and Semmler, Willi, Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model (February 21, 2022). Available at SSRN: https://ssrn.com/abstract=3433707 or http://dx.doi.org/10.2139/ssrn.3433707

Francesco Simone Lucidi (Contact Author)

University of Naples Federico II ( email )

Via Cintia, 21, Monte S. Angelo
Napoli, 80126
Italy

HOME PAGE: http://francescosimonelucidi.com

Willi Semmler

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

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