The Role of Financial Frictions During the Crisis: An Estimated DSGE Model

National Bank of Belgium Working Paper No. 249

44 Pages Posted: 13 Dec 2013

See all articles by Rossana Merola

Rossana Merola

International Labour Organization (ILO)

Date Written: December 2013

Abstract

After the recent banking crisis in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. This paper provides a quantitative assessment of the impact of financial frictions on the U.S. business cycle. The analysis compares the original Smets and Wouters model (2003, 2007) with an alternative version augmented with the financial accelerator mechanism à la Bernanke, Gertler and Gilchrist (1996,1999). Both versions are estimated using Bayesian techniques over a sample extended to 2012. The analysis supports the role of financial channels, namely the financial accelerator mechanism, in transmitting dysfunctions from financial markets to the real economy. The Smets and Wouters model, augmented with the financial accelerator mechanism, is suitable to capture much of the historical developments in U.S. financial markets that led to the financial crisis. The model can account for the output contraction in 2008, as well as the widening in corporate spreads and supports the argument that financial conditions have amplified the U.S. business cycle and the intensity of the recession.

Keywords: DSGE models, business cycle, financial frictions, Bayesian estimation

JEL Classification: C11, E32, E44

Suggested Citation

Merola, Rossana, The Role of Financial Frictions During the Crisis: An Estimated DSGE Model (December 2013). National Bank of Belgium Working Paper No. 249, Available at SSRN: https://ssrn.com/abstract=2366823 or http://dx.doi.org/10.2139/ssrn.2366823

Rossana Merola (Contact Author)

International Labour Organization (ILO) ( email )

Route des Morillons 4
Geneva, 1211
Switzerland

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