Why Does Risk Matter More in Recessions than in Expansions?

Event Date: 24 November 2021

Speaker: Efrem Castelnuovo, professor in the economics department at University of Padova.

Time: 4pm

Please contact Rachel Hill (r.hill@strath.ac.uk) for Zoom details.

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.

If you would like to read the full paper, please click here.

Published: 6 October 2021