Managing Macrofinancial Risk

Author: Mr. Tobias Adrian and Mr. Francis Vitek

Volume/Issue: Volume 2020 Issue 151

Publication date: August 2020

ISBN: 9781513550893

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Topics covered in this book

This title contains information about the following subjects. Click on a subject if you would like to see other titles with the same subjects.

Banks and Banking , Economics- Macroeconomics , WP , math display , business cycle , markup shock , default rate relationship , risk premium , output gap , price level , stochastic process , capital stock , probability density function , gross domestic product , marginal revenue , bank credit , Mortgages , Production growth , Macroprudential policy , Short term interest rates , Housing prices , Monetary policy , Endogenous risk , Financial cycle , Growth at risk , Dynamic stochastic general equilibrium model , State dependent conditional heteroskedasticity , default shock , loan rate , maximization problem , rate determination , constant returns to scale , utility function

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Summary

We augment a linearized dynamic stochastic general equilibrium (DSGE) model with a tractable endogenous risk mechanism, to support the joint analysis of monetary and macroprudential policy. This state dependent conditional heteroskedasticity mechanism specifies the conditional variances of structural shocks as functions of the business or financial cycle. The resultant heteroskedastic linearized DSGE model preserves the satisfactory simulation and forecasting performance of its nested homoskedastic counterpart for the conditional means of endogenous variables, while substantially improving its goodness of fit to their conditional distributions. In particular, the model matches the key stylized facts of growth at risk. Accounting for state dependent conditional heteroskedasticity makes it optimal for monetary policy to respond more aggressively to the business cycle, and for macroprudential policy to manage the resilience of the banking sector more actively over the financial cycle.