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We present a New Keynesian model with endogenous risk. The conditional output gap volatility depends on the price of risk, giving rise to a vulnerability channel of monetary policy. Lower interest rates not only shift consumption intertemporally but also shift conditional output risk. The model fits estimates of the conditional output gap distribut...
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... impose discipline on our exercise and ensure that our specification ends up nesting the three-equation New Keynesian workhorse model, we restrict parameters common to both to equal the values proposed in Chapter 3 of the Galí (2015) textbook, reproduced in Table 1 The remaining parameters are in Table 2 (2)) and their correlations with η t (columns (3) and (4), respectively). As shown, the overall fit of the NKV is comparable to a model with Equations (1) and (2) replaced by a first-order VAR in X t (Table 3, row 2) 8 . 5 The index aggregates 105 financial market, money market, credit supply, and shadow bank indicators using the filtering methodology of Stock and Watson (1998). ...Similar publications
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We extend the New Keynesian (NK) model to include endogenous risk. Lower interest rates not only shift consumption intertemporally but also conditional output risk via their impact on risk-taking, giving rise to a vulnerability channel of monetary policy. The model fits the conditional output gap distribution and can account for medium-term increas...
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Citations
... In a similar fashion, we calibrate V (·) so that the NKV model delivers two empirical features displayed in Panel a of Figure 1: 23 i) the conditional median and volatility of output gap growth correlate negatively, and ii) the negative bivariate relationship is characterized by a high R 2 (0.91). The combination of these facts is important because it ensures the skewed dynamics of output gap growth quantiles discussed in Adrian, Duarte, Liang, and Zabczyk (2020), and also generates a smooth conditional 95 th quantile, and a more volatile conditional 5 th quantile. 24 In other words, a model that delivers (i) and (ii) immediately generates a conditional output gap distribution that replicates its empirical counterpart. ...
We extend the New Keynesian (NK) model to include endogenous risk. Lower interest rates not only shift consumption intertemporally but also conditional output risk via their impact on risk-taking, giving rise to a vulnerability channel of monetary policy. The model fits the conditional output gap distribution and can account for medium-term increases in downside risks when financial conditions are loose. The policy prescriptions are very different from those in the standard NK model: monetary policy that focuses purely on inflation and output-gap stabilization can lead to instability. Macroprudential measures can mitigate the intertemporal risk-return tradeoff created by the vulnerability channel.
We show that the conditional distribution of forecasted GDP growth depends on financial conditions in a panel of 11 advanced economies. Financial conditions have a larger effect on the lower fifth percentile of conditional growth—which we call growth-at-risk (GaR)—than the median. In addition, the term structure of GaR reflects that when initial financial conditions are loose, downside risks are lower in the near term but increase in later quarters. This intertemporal tradeoff for loose financial conditions is amplified when credit-to-GDP growth is rapid. Using granular instrumental variables, we also provide evidence that the relationship from loose financial conditions to future downside risks is causal. Our results suggest that models of macrofinancial linkages should incorporate the endogeneity of higher-order moments to systematically account for downside risks to growth in the medium run. (JEL E23, E27, E32, E44)
This paper quantitatively examines which of the following three widely-used leaning-against-the-wind policies is effective in stabilizing aggregate fluctuations: i) a monetary policy that responds to the loan-to-GDP ratio, ii) a countercyclical LTV policy, and iii) a countercyclical capital requirement policy. In particular, we estimate a New Keynesian model with financial frictions using U.S. data and find that a monetary policy rule that responds positively to the loan-to-GDP ratio Amplifies the macroeconomic fluctuations while a countercyclical LTV policy has almost no effect. On the contrary, a countercyclical capital requirement policy is the most desirable in stabilizing GDP, inflation, and loans. However, the stabilization effect of the optimal countercyclical capital requirement policy is concentrated during periods in which financial shocks played a large role.
