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Introducing financial frictions and unemployment into a small open economy model

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  • Christiano, Lawrence J.
  • Trabandt, Mathias
  • Walentin, Karl

Abstract

Which are the main frictions and the driving forces of business cycle dynamics in an open economy? To answer this question we extend the standard new Keynesian model in three dimensions: we incorporate financing frictions for capital, employment frictions for labor and extend the model into a small open economy setting. We estimate the model on Swedish data. Our main results are that (i) a financial shock is pivotal for explaining fluctuations in investment and GDP. (ii) The marginal efficiency of investment shock has negligible importance. (iii) The labor supply shock is unimportant in explaining GDP and no high frequency wage markup shock is needed.

Suggested Citation

  • Christiano, Lawrence J. & Trabandt, Mathias & Walentin, Karl, 2011. "Introducing financial frictions and unemployment into a small open economy model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 1999-2041.
  • Handle: RePEc:eee:dyncon:v:35:y:2011:i:12:p:1999-2041
    DOI: 10.1016/j.jedc.2011.09.005
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    More about this item

    Keywords

    DSGE model; Financial frictions; Employment frictions; Small open economy; Bayesian estimation;
    All these keywords.

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • F0 - International Economics - - General
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets
    • J6 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers

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