Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model

No 217, Working Papers in Public Economics from Department of Economics and Law, Sapienza University of Roma

Abstract: We build a small-scale nonlinear quadratic (NLQ) model in which credit feedback and regime switches in the output gap a ect the adjustment path of the economy towards a steady state. The central bank solves a finite-horizon decision problem where the policy rate also can be zero or negative. We estimate this model by nonlinear seemingly unrelated regression method (NLSUR) and using the parameters to explore policy scenarios. The latter projects long-run dynamics after a large demand contraction leading to scarring effects in the economy. We point out three main results. First, while scars are dominant when the central bank follows a standard Taylor rule, unconventional monetary policy (UMP) mitigates the output decline in both the short and the long run. Second, a zero natural rate of interest alone curtails the central bank's ability to adjust the economy. Third, financial constraints leave the deepest scars even if UMP is active.

Keywords: credit cycles; credit spread; inflation targeting; nonlinear Phillips curve; unconventional monetary policy (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Pages: 28
Date: 2022-03
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-mac and nep-mon
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Journal Article: Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model (2023)
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