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Financial intermediation, investment dynamics and business cycle fluctuations

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  • Ajello, Andrea

Abstract

How important are financial friction shocks in business cycles fluctuations? To answer this question, I use micro data to quantify key features of US financial markets. I then construct a dynamic equilibrium model that is consistent with these features and fit the model to business cycle data using Bayesian methods. In my micro data analysis, I establish facts that may be of independent interest. For example, I find that a substantial 33% of firm investment is funded using financial markets. The dynamic model introduces price and wage rigidities and a financial intermediation shock into Kiyotaki and Moore (2008). According to the estimated model, the financial intermediation shock explains around 40% of GDP and 55% of investment volatility. The estimation assigns such a large role to the financial shock for two reasons: (i) the shock is closely related to the interest rate spread, and this spread is strongly countercyclical and (ii) according to the model, the response in consumption, investment, employment and asset prices to a financial shock resembles the behavior of these variables over the business cycle.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 32447.

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Date of creation: Nov 2010
Date of revision: Mar 2011
Handle: RePEc:pra:mprapa:32447

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Keywords: DSGE model; Bayesian estimation; Financial frictions; Financial Shocks; Great Recession;

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Financial intermediation, investment dynamics and business cycle fluctuations
    by Christian Zimmermann in NEP-DGE blog on 2011-08-05 03:09:24
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Cited by:
  1. Mimir, Yasin, 2012. "Financial intermediaries, credit Shocks and business cycles," MPRA Paper 39648, University Library of Munich, Germany.
  2. Francesco Furlanetto & Francesco Ravazzolo & Samad Sarferaz, 2014. "Identification of financial factors in economic fluctuations," Working Paper, Norges Bank 2014/09, Norges Bank.
  3. Soeren Radde & Wei Cui, 2013. "Search-Based Endogenous Illiquidity, Business Cycles and Monetary Policy," 2013 Meeting Papers, Society for Economic Dynamics 1009, Society for Economic Dynamics.
  4. Vivek Prasad, 2014. "Balanced budget stimulus with tax cuts in a liquidity constrained economy," Birkbeck Working Papers in Economics and Finance, Birkbeck, Department of Economics, Mathematics & Statistics 1401, Birkbeck, Department of Economics, Mathematics & Statistics.
  5. Shouyong Shi & Christine Tewfik, 2013. "Financial Frictions, Investment Delay and Asset Market Interventions," Working Papers tecipa-501, University of Toronto, Department of Economics.
  6. Engin Kara & Jasmin Sin, 2013. "Liquidity, Quantitative Easing and Optimal Monetary Policy," Bristol Economics Discussion Papers 13/635, Department of Economics, University of Bristol, UK.
  7. Lawrence Christiano & Daisuke Ikeda, 2011. "Government Policy, Credit Markets and Economic Activity," NBER Working Papers 17142, National Bureau of Economic Research, Inc.
  8. Shouyong Shi, 2012. "Liquidity, Assets and Business Cycles," Working Papers tecipa-459, University of Toronto, Department of Economics.
  9. Marco Del Negro & Gauti Eggertsson & Andrea Ferrero & Nobuhiro Kiyotaki, 2011. "The great escape? A quantitative evaluation of the Fed’s liquidity facilities," Staff Reports, Federal Reserve Bank of New York 520, Federal Reserve Bank of New York.

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