Title: Credit spread, financial stress, and delayed monetary policy effectiveness
Authors: Helmut Maurer - Muenster (Germany)
Willi Semmler - New School for Social Research (United States) [presenting]
Pu Chen - Melbourne Institute of Technology (Australia)
Abstract: Given the long period of expansionary monetary policies following the great recession 2008-9, many observers claim that those policies exerted their effects on the real economy through the asset market: Through the decline of financial stress, the repricing of credit risk, and declining credit spreads. To study this channel we propose a regime-switching macro model with financial stress, credit flows, and credit spreads. We study the stabilizing - destabilizing effects of the dynamics of the financial conditions on inflation and output gap. Given different regimes of financial conditions, we explore the effectiveness of conventional and unconventional monetary policies under simultaneous and delayed policy impacts. We use calibrated parameters, based on data for the Euro area, and solve the implied nonlinear dynamic system through AMPL for a finite horizon model. We find that with longer delays policies might not be able to effectively stabilize inflation and the output gap in particular if a regime switch has occurred. Though in our context the agents are forward-looking over a finite horizon, there are effects from the past that come into play with a delay affecting real and financial variables. The possibility of asymmetric adjustments in different regimes to some long-run steady state is then empirically validated through a Multi-Regime-Cointegration-VAR (MRCIVAR) for European countries as well for the US.