Why does risk matter more in recessions than in expansions?

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Title: Why does risk matter more in recessions than in expansions?
Author: Andreasen, Martin M. ; Caggiano, Giovanni ; Castelnuovo, Efrem ; Pellegrino, Giovanni
Organization: Bank of Finland
Series: Bank of Finland Research Discussion Papers
Series number: 13/2021
Year of publication: 2021
Publication date: 5.10.2021
Pages: 44
Subject (yso): laskusuhdanne; noususuhdanne; suhdannevaihtelut; epävarmuus; riskit; mallit
Other keywords: New Keynesian Model; Nonlinear SVAR; Non-recursive identifcation; State-dependent uncertainty shock; Risky steady state
Abstract: This paper uses a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that firms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher inflation volatility and higher marginal utility of consumption than expansions.
Rights: https://helda.helsinki.fi/bof/copyright

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