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Financial frictions and changing macroeconomic volatility

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  • Richard Higgins, C.

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.

Suggested Citation

  • Richard Higgins, C., 2020. "Financial frictions and changing macroeconomic volatility," Journal of Macroeconomics, Elsevier, vol. 64(C).
    • Handle: RePEc:eee:jmacro:v:64:y:2020:i:c:s0164070419302629
    DOI: 10.1016/j.jmacro.2020.103204
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    More about this item

    Keywords

    Great moderation; Financial frictions; Stochastic volatility; Parameter drifting; Dynamic equilibrium models;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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