The effects of monetary policy on macroeconomic downside risk: state-dependence matters

I study the dynamic causal relationship between monetary policy and macroeconomic downside risk, focusing on structural asymmetries in recessions and expansions. I find that a monetary easing during economic slowdowns reduces downside risk by about twice as much as a monetary tightening during booms increases it. If this asymmetry is not properly accounted for, it could lead to an overly cautious behaviour by policymakers when tightening during booms; the conclusion also holds when considering monetary contractions occurring during highly-leveraged expansions. Results align with theoretical models that include a financial accelerator mechanism. I obtain evidence by building downside risk indicators as linear combinations of relevant quantiles of the conditional forecast density of output growth. Generalised state-dependent impulse response functions to structural shocks of quantiles linear combinations are recovered using a novel econometric framework that mixes structural VAR and quantile regressions, both adapted to accommodate smooth-transition parameters.