Time-Varying Volatility, Financial Intermediation and Monetary Policy

49 Pages Posted: 14 Dec 2016

See all articles by Sandra Eickmeier

Sandra Eickmeier

Deutsche Bundesbank

Norbert Metiu

Deutsche Bundesbank

Esteban Prieto

Deutsche Bundesbank - Economic Research Centre

Multiple version iconThere are 2 versions of this paper

Date Written: 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. 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 banks endogenously choose their capital structure. In the model, the leverage choice of banks depends on the volatility of aggregate shocks. In low volatility periods, banks 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.

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 (2016). Bundesbank Discussion Paper No. 46/2016. Available at SSRN: https://ssrn.com/abstract=2885074

Sandra Eickmeier (Contact Author)

Deutsche Bundesbank ( email )

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

Norbert Metiu

Deutsche Bundesbank ( email )

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

Esteban Prieto

Deutsche Bundesbank - Economic Research Centre ( email )

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

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