Understanding the Aggregate Effects of Credit Frictions and Uncertainty

50 Pages Posted: 15 Jun 2017

See all articles by Nathan S. Balke

Nathan S. Balke

Southern Methodist University (SMU) - Department of Economics; Federal Reserve Bank of Dallas - Research Department

Enrique Martínez-García

Federal Reserve Bank of Dallas - Research Department

Zheng Zeng

Bowling Green State University, Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: June 12, 2017

Abstract

This paper integrates a financial accelerator mechanism à la Bernanke et al. (1999) and time-varying 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 (micro-uncertainty), 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.

Keywords: Stochastic Volatility, Uncertainty, Financial Accelerator, Perturbation Methods

JEL Classification: E32, E44, D8, C32

Suggested Citation

Balke, Nathan S. and Martinez-Garcia, Enrique and Zeng, Zheng, Understanding the Aggregate Effects of Credit Frictions and Uncertainty (June 12, 2017). Available at SSRN: https://ssrn.com/abstract=2986461 or http://dx.doi.org/10.2139/ssrn.2986461

Nathan S. Balke

Southern Methodist University (SMU) - Department of Economics ( email )

Dallas, TX 75275
United States
214-768-2693 (Phone)
214-768-1821 (Fax)

Federal Reserve Bank of Dallas - Research Department

PO Box 655906
Dallas, TX 75265-5906
United States

Enrique Martinez-Garcia (Contact Author)

Federal Reserve Bank of Dallas - Research Department ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5262 (Phone)

HOME PAGE: http://sites.google.com/view/emgeconomics

Zheng Zeng

Bowling Green State University, Department of Economics ( email )

Bowling Green, OH 43403
United States
419-372-8397 (Phone)

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