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

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.