Financial frictions and changing macroeconomic volatility |
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| Affiliation: | 1. Northeast Asian Studies College, Jilin University, China;2. Department of Economics, University of Washington, USA;3. Department of Economics, Korea University, 145 Anamro, Seongbuk-Gu, Seoul 02841, South Korea;1. Department of Quantitative Economics, School of Business and Economics, Maastricht University, Maastricht, The Netherlands;2. Faculty of Economics and Business, University of Groningen, PO Box 800, 9700 AV, Groningen, The Netherlands;3. University of Tasmania, Australia;4. CAMA, Australia;5. CIRANO, Canada;6. Management School, University of Liverpool, Liverpool, UK;1. Washington University, St. Louis, USA;2. Federal Reserve Bank of St. Louis, USA;3. University of Milan, Department of Economics, Management, and Quantitative Methods, Italy |
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| Abstract: | This paper studies the impact of changing financial frictions on the Great Moderation using an estimated, nonlinear New Keynesian model. The model features financial frictions, parameter drift, and stochastic volatility. The estimation results show that financial frictions fell during the 1980s and remained low throughout the Great Moderation. Based on counterfactual studies, the reduction in financial frictions was an important reason for the reduction in volatility observed during the Great Moderation. The results show little role for changing monetary policy or reduced shock volatility, two common explanations, in causing the Great Moderation. |
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