Nonlinearities in the Transmission Between Financial Stress, Monetary Policy and the Business Cycle - a Threshold VAR Approach

Abstract: This paper investigates nonlinear transmissions between financial stress, monetary policy and the business cycle. Using a threshold VAR model on Swedish quarterly data the presence of nonlinearities in aforementioned transmission is corroborated by the nonlinearity-test suggested by Hansen (1996). Further, a nonlinear impulse-response analysis reveals several results worthwhile mentioning; (i) shocks occurring in a financially stressful regime on average seem to have a greater impact on GDP growth; (ii) monetary policy shocks during financially stressful times seem to have a greater and more immediate but less persistent effect on output growth; (iii) financial shocks occurring in times already characterized by high financial stress create larger contractions in output growth compared to those occurring under low financial stress and (iv); positive GDP growth shocks starting in periods characterized by high financial stress seem to worsen the level of financial stress.