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Financial factors and the international transmission mechanism

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  • Haddow, Abigail

    ()
    (Bank of England)

  • Mileva, Mariya

    ()
    (Kiel Institute for the World Economy)

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    Abstract

    The aim of this paper is to investigate theoretically how financial factors affect the international transmission mechanism. We build a two-country dynamic stochastic general equilibrium model with sticky prices and financial frictions. To add to the literature we extend the model to include two types of credit spread shocks that are micro-founded; a mean preserving shock to the dispersion of firms idiosyncratic productivity (risk shock) and a shock to financial agents net worth (financial wealth shock). We find that the source of the shock to the credit spread matters; credit spread shocks of equivalent size, but driven by different innovations, have different consequences for output and inflation in the home and foreign economy. In general risk shocks generate more realistic spillovers to activity than a financial wealth shock.

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    Bibliographic Info

    Paper provided by Bank of England in its series Bank of England working papers with number 479.

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    Length: 28 pages
    Date of creation: 16 Aug 2013
    Date of revision:
    Handle: RePEc:boe:boeewp:0479

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    Related research

    Keywords: International transmission mechanism; financial frictions; financial shocks; DSGE model;

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    1. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
    2. Michał Brzoza-Brzezina & Marcin Kolasa & Krzysztof Makarski, 2011. "The anatomy of standard DSGE models with financial frictions," National Bank of Poland Working Papers 80, National Bank of Poland, Economic Institute.
    3. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
    4. Michael B. Devereux & Alan Sutherland, 2008. "Country Portfolios in Open Economy Macro Models," NBER Working Papers 14372, National Bureau of Economic Research, Inc.
    5. Robert E. Hall, 1999. "The Stock Market and Capital Accumulation," NBER Working Papers 7180, National Bureau of Economic Research, Inc.
    6. Virginia Queijo von Heideken, 2009. "How Important are Financial Frictions in the United States and the Euro Area?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 111(3), pages 567-596, 09.
    7. Sebastian Dyrda & Greg Kaplan & José-Víctor Ríos-Rull, 2012. "Business Cycles and Household Formation: The Micro vs the Macro Labor Elasticity," NBER Working Papers 17880, National Bureau of Economic Research, Inc.
    8. Ian Christensen & Ali Dib, 2008. "The Financial Accelerator in an Estimated New Keynesian Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(1), pages 155-178, January.
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