Monetary Policy and Growth at Risk: The Role of Financial Conditions

Abstract Previous studies mainly examine the monetary policy transmission to average growth outcomes, this paper instead studies the effects of monetary policy on the tail outcomes of GDP growth – Growth at Risk (GaR). We first use quantile regression to estimate the conditional distribution of GDP growth, and then estimate the impulse responses with smooth local projections. Our results show that GaR deteriorates in response to contractionary monetary policy shocks, suggesting an increase in macroeconomic tail risk. We investigate the role of financial conditions in the transmission of monetary policy to GaR. We find that contractionary monetary policy shocks lead to tighter financial conditions, and tighter financial conditions have significant negative effects on GaR. Moreover, we show that tighter financial conditions increase future recession risk in both the short and medium term.