Credit Conditions and the Effects of Economic Shocks: Amplification and Asymmetries

In this paper we address three empirical questions related to credit conditions. First, do they change the dynamic interactions of economic variables? Second, do they enlarge the effects of economic shocks? Third, do they generate asymmetries in the effects of economic shocks? To answer these questions, we introduce endogenous regime switching in the parameters of a large Multivariate Autoregressive Index (MAI) model, where all variables react to a set of observable common factors. We develop Bayesian estimation methods and show how to compute responses to common structural shocks. We find that credit conditions do act as a trigger variable for regime changes. Moreover, demand and supply shocks are amplified when they hit the economy during periods of credit stress. Finally, good shocks seem to have more positive effects during stress time, in particular on unemployment.

(with A. Carriero and M. Marcellino)