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Uncertainty and Monetary Policy in Good and Bad Times

Author

Listed:
  • Giovanni Caggiano

    (University of Padova)

  • Efrem Castelnuovo

    (University of Padova)

  • Gabriela Nodari

    (University of Verona)

Abstract
We employ a nonlinear VAR to document the asymmetric reaction of real economic activity to uncertainty shocks. An uncertainty shock occurring in recessions triggers an abrupt and deep drop followed by a quick rebound and a temporary overshoot. The same shock hitting in expansions induces a milder slowdown, a longer-lasting recovery, and no overshoot. The employment of linear models is shown to offer a distorted picture of the timing and the severity of heightened uncertainty. Monetary policy responds quite aggressively during bad times, and more mildly during booms. Counterfactual simulations point to monetary policy ineffectiveness during the first months after the shock, especially in recessions, and to policy effectiveness in the medium-term, especially during expansions. This holds true considering as policy tools both the federal funds rate and a long-term interest rate. Our results call for microfounded models admitting nonlinear effects of uncertainty shocks.

Suggested Citation

  • Giovanni Caggiano & Efrem Castelnuovo & Gabriela Nodari, 2014. "Uncertainty and Monetary Policy in Good and Bad Times," "Marco Fanno" Working Papers 0188, Dipartimento di Scienze Economiche "Marco Fanno".
    • Handle: RePEc:pad:wpaper:0188
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    More about this item

    Keywords

    Uncertainty shocks; nonlinear Smooth Transition Vector AutoRegressions; Generalized Impulse Response Functions; systematic monetary policy; forward guidance.;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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