Financial Shocks, Uncertainty Shocks, and Monetary Policy Trade-Offs

Marco Brianti

No 2021-5, Working Papers from University of Alberta, Department of Economics

Abstract: This paper separately identifies financial and uncertainty shocks using a novel SVAR procedure and discusses their distinct monetary policy implications. The procedure relies on the qualitatively different responses of corporate cash holdings: after a financial shock, firms draw down their cash reserves as they lose access to external finance, while uncertainty shocks drive up cash holdings for precautionary reasons. Although both financial and uncertainty shocks are contractionary, my results show that the former are inflationary while the latter generate deflation. I rationalize this pattern in a New-Keynesian model: after a financial shock, firms increase prices to raise current liquidity; after an uncertainty shock, firms cut prices in response to falling demand. These distinct channels have stark monetary policy implications: conditional on uncertainty shocks, the monetary authority can potentially stabilize output and inflation at the same time, while in the case of financial shocks, the central bank can stabilize inflation only at the cost of more unstable output fluctuations.

Keywords: financial shocks; uncertainty shocks; SVAR; inflation; monetary policy (search for similar items in EconPapers)
JEL-codes: E30 E31 E32 E44 (search for similar items in EconPapers)
Pages: 77 pages
Date: 2021-08-02
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:ris:albaec:2021_005

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