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Effects of US Monetary Policy Shocks During Financial Crises - A Threshold Vector Autoregression Approach

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  • Jasmine Zheng

Abstract

This paper analyzes the impact and effectiveness of conventional monetary policy during periods of low and high financial stress in the US economy. Using data from 1973Q1 to 2008Q4, the analysis is conducted by estimating a Threshold Vector Autoregression (TVAR) model to capture switching between the low and high financial stress regimes implied by the theoretical literature. The empirical findings support regime-dependent effects of conventional US monetary policy. In particular, the output response to monetary policy shocks is larger during periods of high financial stress than in periods of low financial stress. The existence of a cost channel effect during periods of high financial stress imply a worsening of the short run output-inflation trade off during financial crises. When the sample period is extended to 2012Q4, there is evidence that expansionary monetary policy continues to be effective during periods of high financial stress when the prevailing interest rate is at the zero lower bound. By keeping interest rates and credit spreads low, expansionary monetary policy helps shift the US economy from high to low financial stress regimes. Large expansionary monetary policy shocks also increase the likelihood of moving the economy out of a high financial stress regime.

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File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2013-09/64_2013_zheng.pdf
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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2013-64.

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Length: 48 pages
Date of creation: Sep 2013
Date of revision:
Handle: RePEc:een:camaaa:2013-64

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Keywords: Monetary policy; uncertainty; threshold vector autoregression models;

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  1. Nathan S. Balke, 2000. "Credit and Economic Activity: Credit Regimes and Nonlinear Propagation of Shocks," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 344-349, May.
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  7. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  8. Azariadis, Costas & Smith, Bruce, 1998. "Financial Intermediation and Regime Switching in Business Cycles," American Economic Review, American Economic Association, vol. 88(3), pages 516-36, June.
  9. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
  10. Weise, Charles L, 1999. "The Asymmetric Effects of Monetary Policy: A Nonlinear Vector Autoregression Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(1), pages 85-108, February.
  11. Peersman, Gert & Smets, Frank, 2001. "Are the effects of monetary policy in the euro area greater in recessions than in booms?," Working Paper Series 0052, European Central Bank.
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