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Understanding the Aggregate Effects of Credit Frictions and Uncertainty
We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. To do so, uncertainty is modeled as time-varying stochastic volatility ? the product of monetary policy uncertainty, financial risk (micro-uncertainty), and macrouncertainty. The model is solved using a pruned third-order approximation and estimated by the Simulated Method of Moments. We find that: 1) Micro-uncertainty aggravates the information asymmetry between lenders and borrowers, worsens credit conditions, and has first-order effects on real economic activity. 2) When credit conditions are poor, ...