What Drives the Asymmetrical and Non-linear Effects of Monetary Policy Shocks? Investigating Recession Dynamics, Shock Direction, and Magnitude Variations.

Abstract

This research investigates the state-dependent effects of monetary policy, focusing on how economic conditions—such as recessions, expansions, and inflation regimes—shape the trans- mission of monetary shocks. Building on state-dependent pricing models and incorporating insights from dynamic stochastic general equilibrium (DSGE) frameworks, we examine how price adjustment mechanisms vary across different economic states and their implications for inflation and output dynamics. We formulate three key hypotheses: (i) monetary policy is less effective in boosting real activ- ity during recessions than in non-recessionary periods, (ii) the real effects of monetary policy shocks are asymmetric, with contractionary shocks generating stronger effects than expan- sionary ones, and (iii) smaller monetary policy shocks yield proportionally stronger real effects than larger shocks. Our findings provide strong empirical validation for state-dependent pricing models. During recessions, heightened volatility and demand slack lead to greater price flexibility, which damp- ens the real effects of monetary policy while accelerating inflationary responses. In contrast, non-recessionary periods exhibit greater price stickiness, allowing for stronger and more per- sistent real effects. We confirm the asymmetry of monetary policy, as contractionary shocks have disproportionately larger real effects than expansionary shocks, particularly during reces- sions. Furthermore, small monetary shocks are more effective in influencing real activity, while larger shocks are absorbed more quickly into inflation, reducing their persistence and impact on output.