Credit Shocks, Monetary Policy, and Business Cycles: Evidence from a Structural Time Varying Bayesian FAVAR

I estimate a Bayesian factor-augmented vector autoregression model using a large panel of macroeconomic and credit spread data from the United States for the period 1926-2009. The model has time varying parameters and volatilities. I identify a number of episodes with high volatility in the common component of credit spreads. Often, though not always, these episodes coincide with (or lead) NBER recessions. I find that, during these episodes, credit spread shocks and monetary policy shocks have much stronger effects on macroeconomic variables than on average. The degree of amplification of those responses reaches at its peak a factor of up to ten. These amplified responses tend to exhibit a larger persistence.