Time-Varying Volatility, Financial Intermediation and Monetary Policy

55 Pages Posted: 1 Jun 2016

See all articles by Sandra Eickmeier

Sandra Eickmeier

Deutsche Bundesbank; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Norbert Metiu

Deutsche Bundesbank

Esteban Prieto

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: May 30, 2016

Abstract

We document that expansionary monetary policy shocks are less effective at stimulating output and investment in periods of high volatility compared to periods of low volatility, using a regime-switching vector autoregression. Exogenous policy changes are identified by adapting an external instruments approach to the non-linear model. The lower effectiveness of monetary policy can be linked to weaker responses of credit costs, suggesting a financial accelerator mechanism that is weaker in high volatility periods. To rationalize our robust empirical results, we use a macroeconomic model in which financial intermediaries endogenously choose their capital structure. In the model, the leverage choice of banks depends on the volatility of aggregate shocks. In low volatility periods, financial intermediaries lever up, which makes their balance sheets more sensitive to aggregate shocks and the financial accelerator more effective. On the contrary, in high volatility periods banks decrease leverage, which renders the financial accelerator less effective; this in turn decreases the ability of monetary policy to improve funding conditions and credit supply, and thereby to stimulate the economy. Hence, we provide a novel explanation for the non-linear effects of monetary stimuli observed in the data, linking the effectiveness of monetary policy to the procyclicality of leverage.

Keywords: Monetary policy, credit spread, non-linearity, intermediary leverage, financial accelerator

JEL Classification: C32, E44, E52

Suggested Citation

Eickmeier, Sandra and Metiu, Norbert and Prieto, Esteban, Time-Varying Volatility, Financial Intermediation and Monetary Policy (May 30, 2016). CAMA Working Paper No. 32/2016 , Available at SSRN: https://ssrn.com/abstract=2786821 or http://dx.doi.org/10.2139/ssrn.2786821

Sandra Eickmeier (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Strasse 14
Frankfurt/Main D-60431
Germany

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

Norbert Metiu

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Esteban Prieto

affiliation not provided to SSRN

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