Staff Working Paper No. 931
By David Aikman, Kristina Bluwstein and Sudipto Karmakar
We build a semi-structural New Keynesian model to study the drivers of macroeconomic tail risk (‘GDP-at-Risk’). Our model features three key non-linearities: a lower bound on nominal interest rates; a credit crunch in bank loan supply when bank capital depletes; and deleveraging by borrowers when debt service burdens become excessive. These non-linearities can interact to amplify GDP-at-Risk: for example, when debt burdens rise sufficiently, this increases the risk of debt deleveraging but also that of a credit crunch and hitting the effective lower bound. We simulate a persistent inflation shock to analyse how these interactions might operate at this juncture.
This version was updated in January 2023.