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Does risk matter more in recessions than in expansions? Implications for monetary policy

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  • Andreasen, Martin M.
  • Caggiano, Giovanni
  • Castelnuovo, Efrem
  • Pellegrino, Giovanni

Abstract

We employ a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences replicates these state-contingent responses when approximated to third order around its risky steady state due to a stronger upward nominal pricing bias in recessions than in expansions. Empirical evidence supports this state-contingent channel, and we show that it can greatly reduce the ability of systematic monetary policy to stabilize output during recessions.

Suggested Citation

  • Andreasen, Martin M. & Caggiano, Giovanni & Castelnuovo, Efrem & Pellegrino, Giovanni, 2024. "Does risk matter more in recessions than in expansions? Implications for monetary policy," Journal of Monetary Economics, Elsevier, vol. 143(C).
    • Handle: RePEc:eee:moneco:v:143:y:2024:i:c:s0304393223001290
    DOI: 10.1016/j.jmoneco.2023.10.014
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    Keywords

    New Keynesian model; Nonlinear SVAR; Non-recursive identification; State-contingent uncertainty shock; Risky steady state;
    All these keywords.

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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