Understanding the Aggregate Effects of Credit Frictions and Uncertainty

55 Pages Posted: 21 Jun 2017 Last revised: 29 Apr 2020

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, 2017

Abstract

We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. To do so, uncertainty is modeled as time-varying stochastic volatitlity - the product of monetary policy uncertainty, financial risk (micro-uncertainty), and macrouncertainty. The model is solved using a pruned third-order approximation and estimated by the Simulated Method of Moments. We find that: 1) Micro-uncertainty aggravates the information asymmetry between lenders and borrowers, worsens credit conditions, and has first-order effects on real economic activity. 2) When credit conditions are poor, as indicated by elevated credit spreads, additional micro-uncertainty shocks produce even larger real effects. 3) Poor credit conditions notably affect the transmission mechanism of monetary policy amplifying the real effects of monetary shocks while mitigating the economic boost from TFP shocks. 4) While macro-uncertainty and policy uncertainty exert relatively little direct impact on aggregate economic activity, policy uncertainty accounts for around 40% of the business cycle volatility by affecting the size of monetary policy shocks in the presence of nominal rigidities.

JEL Classification: C32, D8, E32, E44

Suggested Citation

Balke, Nathan S. and Martinez-Garcia, Enrique and Zeng, Zheng, Understanding the Aggregate Effects of Credit Frictions and Uncertainty (June, 2017). Globalization and Monetary Policy Institute Working Paper No. 317, Available at SSRN: https://ssrn.com/abstract=2990310 or http://dx.doi.org/10.24149/gwp317r1

Nathan S. Balke (Contact Author)

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

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United States
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Federal Reserve Bank of Dallas - Research Department

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Enrique Martinez-Garcia

Federal Reserve Bank of Dallas - Research Department ( email )

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Dallas, TX 75265-5906
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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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