*Source of the Great Recession DOI: http://dx.doi.org/10.5772/intechopen.90729*

**Figure 9.**

Finally, we turn to analyzing the monetary policy in the Great Recession and after it including an unconventional monetary policy by FRB such as Round 1 of quantitative easing policy (QE1), between 2008:Q4 and 2010:Q2 and Round 2 of quantitative easing policy (QE2) between 2010:Q4 and 2011:Q2, although our monetary policy rule follows linearized Taylor rules. As the fourth row of

*Historical decomposition of investment. (a) Constant volatility Case A. (b) Stochastic volatility Case B. (c) Constant volatility data rich Case C. (d) Stochastic volatility data rich Case D. Notes: See the notes of Figure 7.*

**Figures 4** and **5**, we can find the estimation of monetary policy shocks (deep blue lines) have two big negative troughs in this period for all cases. The first negative trough was identified at 2007:Q4 when the global financial market was disarranged by announcement of the BNP Paribas. And the second trough was ascertained at 2008:Q3, immediately before the FRB implemented QE1. Especially, the sizes of the two big negative shocks are classified in the Cases B and D with SVs shocks, as shown in **Figures 4(b)** and **5(b)**. The fourth row of **Figure 6** also draws the rapid surge of these volatilities of monetary policy shocks between 2007:Q4 and 2008:Q3. In other words, the two unconventional monetary policy might be undertaken more boldly and without hesitation as well as the case of conventional tightening policy

according to the 90% credible band of the SVs.

**Figure 8.**

*Financial Crises - A Selection of Readings*

**44**

*Historical decomposition of borrowing rate. (a) Constant volatility Case A. (b) Stochastic volatility Case B. (c) Constant volatility data rich Case C. (d) Stochastic volatility data rich Case D. Notes: See the notes of Figure 7.*

#### **4.2 Historical decompositions**

Here, we move to discuss about difference of historical decompositions among the four cases. In particular, as can be seen from Figures 7**(a)–(d)**–10**(a)–(d)**, we focus on the periods between 2000:Q1 and 2012:Q2 of the following four observations and model variables, say (1) the real GDP of observations matching to an output gap of model variable, similarly (2) the gross private domestic investment matching to investment, (3) Moody's bond index (corporate Baa) matching to corporate borrowing rate, (4) the commercial banks' leverage ratio matching to the bank leverage ratio. The red and black circle lines represent observations and smoothed estimation, respectively. The differences between both lines indicate measurement errors of observations. In these figures, the light blue shade represents the period of the Great Recession (2007:Q3 to 2009:Q2). In order to make more visible and to concentrate on the contributions of both net-worth shocks of banking sector (deep blue shade area) and corporate sector (green shade area) for the recession by remaining key shocks like the TFP (red shade area) and monetary

policy shocks (yellow shade area), we gathered the other four miscellaneous shocks as one bundle (light blue shade area) in these figures.

cases, a sharp spike of the rate must be mainly contributed for the negative shock of bank net-worth (deep blue shade area) as well as from a drop of the TFP shock (red shade area), while the positive shock of corporate net-worth (green shade area) are likely to account for extending of the rate downward in the recession. On the other hand, TARP might have been effectively workable and made the net-worth of financial firms become positive, that would have contributed to decline of the borrowing rate after 2010:Q1. Especially, these findings are seen in Cases B and D

**Figure 10** shows the decomposition of the commercial banks' leverage ratio, i.e., the ratio of the bank's asset to the bank's net-worth for all four cases. The leverage ratio fluctuates countercyclical as these figures. In the recession, two negative networth shocks of both sectors worsen balance sheet of banking sectors indicating sharp spike of the ratio. But, immediately after starting TARP, bank equity was likely to successfully improve, although the net-worth shock in corporate sector (green shade area) continued negatively and made the corporate balance sheet much worse even during executing TARP in 2010. And the banking loan to corporate sector declined sharply by large deficit of corporate balance sheet. A reduction of banking loan would have brought the banks' leverage ratio to decrease during implement of TARP, because the numerator of the ratio means total of loan and equity in the banks. In fact, we often observe that banking loan declines but corporate bond increases in the recession. However, the countercyclical movement of the bank's leverage ratio was not generated from the banking model by Gertler and Kiyotaki [12] which is one of our financial frictions of banking sector. On the other hand, Adrian et al. [22] intended to describe the reason why the ratio was countercyclical, using a theory of liquidity and leverage proposed by Adrian and Shin [23]. Our findings about two conflicting net-worth shocks in the recession

Through estimation of our model, we found three key findings during the period

of the Great Recession and after it, which has already described in the previous

First, as can be seen from **Figures 4** and **5**, the timing of the two different financial shocks modeling as balance sheet shocks in financial and nonfinancial firms have not arisen simultaneously, but the bank's balance sheet shock has sharply rose prior to the surge of the corporate balance sheet shock. When a financial crisis brings blooming degeneration of both balance sheet, this timing pattern (not concurrent, but sequential timing) must be noted as a lead of endogenous relationship of the balance sheet conditions in both banking sector and the corporate sector. Our model, however, has limitations. That is, we assume the two balance sheet shocks to be independent from each other and further do not allow the corporate sector to keep the bank's equity as an asset of his balance sheet. Thus, it may be inappropriate to interpret the endogenous relationship between the two net-worth shocks. Yet, it is worth noting about remark of the timing pattern of the two financial shocks

Second, we found that during the Great Recession, contributions of corporate balance sheet shock are relatively smaller in models with constant volatility shocks as Cases A and C than in models with SV shocks as Cases B and D as shown in **Figures 7–10**. This result suggests that estimation without the data-rich environment is likely to under-evaluate importance of the corporate balance sheet shock. Furthermore, an accuracy of estimating the corporate balance sheet shocks during

section. Without hesitating duplication, we summarize these points.

seem to be consistent with Adrian et al.'s [22] findings.

**5. Discussion and remark**

during the Great Recession.

**47**

with SV shock.

*Source of the Great Recession*

*DOI: http://dx.doi.org/10.5772/intechopen.90729*

We start to discuss about real activities, say the real GDP and the gross private domestic investment. As shown in **Figures 7** and **8**, the contributions by each shocks show similar proportions between the real GDP and the investment. The decomposition by each shock has the same sign at every period of both variables in all four cases, but the sizes of the contribution of shocks are quite different depending on the cases. For example, the TFP shock (red shade area) accounted for a large portion of the sources of the Great Recession, whereas the bank net-worth (deep blue shade area) explained a small part of drops in Cases A and B. And the positive corporate net-worth (green shade area) increased and contributed to raising these variables by a significant portion during the recession in Case A. Meanwhile, Cases C and D showed that the positive impact by the corporate net-worth shock (green shade area) was smaller than Case A, and that the bank net-worth shock (deep blue shade area) explain a half of the downturn of both variables in the recession as well as the TFP shock.

**Figure 9** draws historical decomposition of a model variable of corporate borrowing rate using an observation of Moody's bond index (corporate Baa). For all

#### **Figure 10.**

*Historical decomposition of bank leverage ratio. (a) Constant volatility Case A. (b) Stochastic volatility Case B. (c) Constant Volatility Data Rich Case C. (d) Stochastic Volatility Data Rich Case D. Notes: See the notes of Figure 7.*

#### *Source of the Great Recession DOI: http://dx.doi.org/10.5772/intechopen.90729*

policy shocks (yellow shade area), we gathered the other four miscellaneous shocks

We start to discuss about real activities, say the real GDP and the gross private domestic investment. As shown in **Figures 7** and **8**, the contributions by each shocks show similar proportions between the real GDP and the investment. The decomposition by each shock has the same sign at every period of both variables in all four cases, but the sizes of the contribution of shocks are quite different depending on the cases. For example, the TFP shock (red shade area) accounted for a large portion of the sources of the Great Recession, whereas the bank net-worth (deep blue shade area) explained a small part of drops in Cases A and B. And the positive corporate net-worth (green shade area) increased and contributed to raising these variables by a significant portion during the recession in Case A. Meanwhile, Cases C and D showed that the positive impact by the corporate net-worth shock (green shade area) was smaller than Case A, and that the bank net-worth shock (deep blue shade area) explain a half of the

**Figure 9** draws historical decomposition of a model variable of corporate borrowing rate using an observation of Moody's bond index (corporate Baa). For all

*Historical decomposition of bank leverage ratio. (a) Constant volatility Case A. (b) Stochastic volatility Case B. (c) Constant Volatility Data Rich Case C. (d) Stochastic Volatility Data Rich Case D. Notes: See the notes of Figure 7.*

as one bundle (light blue shade area) in these figures.

*Financial Crises - A Selection of Readings*

downturn of both variables in the recession as well as the TFP shock.

**Figure 10.**

**46**

cases, a sharp spike of the rate must be mainly contributed for the negative shock of bank net-worth (deep blue shade area) as well as from a drop of the TFP shock (red shade area), while the positive shock of corporate net-worth (green shade area) are likely to account for extending of the rate downward in the recession. On the other hand, TARP might have been effectively workable and made the net-worth of financial firms become positive, that would have contributed to decline of the borrowing rate after 2010:Q1. Especially, these findings are seen in Cases B and D with SV shock.

**Figure 10** shows the decomposition of the commercial banks' leverage ratio, i.e., the ratio of the bank's asset to the bank's net-worth for all four cases. The leverage ratio fluctuates countercyclical as these figures. In the recession, two negative networth shocks of both sectors worsen balance sheet of banking sectors indicating sharp spike of the ratio. But, immediately after starting TARP, bank equity was likely to successfully improve, although the net-worth shock in corporate sector (green shade area) continued negatively and made the corporate balance sheet much worse even during executing TARP in 2010. And the banking loan to corporate sector declined sharply by large deficit of corporate balance sheet. A reduction of banking loan would have brought the banks' leverage ratio to decrease during implement of TARP, because the numerator of the ratio means total of loan and equity in the banks. In fact, we often observe that banking loan declines but corporate bond increases in the recession. However, the countercyclical movement of the bank's leverage ratio was not generated from the banking model by Gertler and Kiyotaki [12] which is one of our financial frictions of banking sector. On the other hand, Adrian et al. [22] intended to describe the reason why the ratio was countercyclical, using a theory of liquidity and leverage proposed by Adrian and Shin [23]. Our findings about two conflicting net-worth shocks in the recession seem to be consistent with Adrian et al.'s [22] findings.
