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Financial Fragmentation Shocks

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Abstract

We define "financial fragmentation shocks" as fluctuations in credit market frictions in a small euro area economy. The shock changes the financial integration status quo of the monetary union, given its negligible international spillover. An increase in credit market frictions triggers a recession in the small economy. Perfect competition and the absence of nominal rigidities attenuate output volatility. Expectations also matter: real impacts weaken when long fragmentation time spans are perceived to be short lived. Contrarily to "risk shocks", defined as fluctuations in borrowers' riskiness, fragmentation shocks do not imply strongly countercyclical bankruptcy rates. The results are based on PESSOA, a general equilibrium model with a Bernanke-Gertler-Gilchrist financial accelerator mechanism.

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  • Gabriela Castro & José R. Maria & Paulo Júlio, 2015. "Financial Fragmentation Shocks," Working Papers w201508, Banco de Portugal, Economics and Research Department.
    • Handle: RePEc:ptu:wpaper:w201508
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    1. Castro, Gabriela & Félix, Ricardo M. & Júlio, Paulo & Maria, José R., 2015. "Unpleasant debt dynamics: Can fiscal consolidations raise debt ratios?," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 276-294.

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