Back to the real economy: the effects of risk perception shocks on the term premium and bank lending

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 21 June 2019

Staff Working Paper No. 806

By Kristina Bluwstein and Julieta Yung

We develop a dynamic stochastic general equilibrium framework that can account for important macroeconomic and financial moments, given Epstein-Zin preferences, heterogeneous banking and third-order approximation methods that yield a time-varying term premium that feeds back to the real economy. A risk perception shock increases term premia, lowers output, and reduces short-term credit in the private sector in response to higher loan rates and constrained borrowers, as banks rebalance their portfolios. A ‘bad’ credit boom, driven by investors mispricing risk, leads to a more severe recession and is less supportive of economic growth than a ‘good’ credit boom based on fundamentals.

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