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Financial Frictions, Financial Shocks, and Aggregate Volatility

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  • Cristina Fuentes-Albero

    ()
    (Rutgers University, Department of Economics)

Abstract

The two main empirical regularities regarding US postwar nominal and real business cycles are the Great Inflation and the Great Moderation. While the volatility of financial price variables also follows such pattern, financial quantity variables have experienced a continuous immoderation. We examine these patterns in volatility by estimating a DSGE model with financial frictions and financial shocks allowing for structural breaks in the size of shocks and the institutional framework. We conclude that (i ) while the Great Inflation was driven by bad luck, the Great Moderation is mostly due to better financial institutions; (ii ) financial shocks are the main drivers of financial variables, investment, and the nominal interest rate and play a secondary role as drivers of consumption, output, inflation, and hours worked; (iii ) investment-specific technology shocks play an almost negligible role as drivers of the US business cycle. Creation-Date: 2012-02-03

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 201201.

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Handle: RePEc:rut:rutres:201201

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Keywords: financial frictions; financial shocks; structural break; Great Moderation; Great Inflation;

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  1. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2004. "The Great Depression and the Friedman-Schwartz hypothesis," Working Paper 0318, Federal Reserve Bank of Cleveland.
  2. Giorgio E. Primiceri & Andrea Tambalotti & Alejandro Justiniano, 2009. "Investment Shocks and the Relative Price of Investment," 2009 Meeting Papers 686, Society for Economic Dynamics.
  3. Urban Jermann & Vincenzo Quadrini, 2006. "Financial Innovations and Macroeconomic Volatility," NBER Working Papers 12308, National Bureau of Economic Research, Inc.
  4. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
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  7. Chang-Jin Kim & Charles R. Nelson, 1999. "Has The U.S. Economy Become More Stable? A Bayesian Approach Based On A Markov-Switching Model Of The Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 608-616, November.
  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.
  9. Andre Kurmann & Julien Champagne, 2010. "The Great Increase in Relative Volatility of Real Wages in the United States," 2010 Meeting Papers 674, Society for Economic Dynamics.
  10. Perron, P. & Bai, J., 1995. "Estimating and Testing Linear Models with Multiple Structural Changes," Cahiers de recherche 9552, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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  12. White, Michelle J, 1983. " Bankruptcy Costs and the New Bankruptcy Code," Journal of Finance, American Finance Association, vol. 38(2), pages 477-88, May.
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Cited by:
  1. Fernández, Andrés & Gulan, Adam, 2012. "Interest rates and business cycles in emerging economies: The role of financial frictions," Research Discussion Papers 23/2012, Bank of Finland.

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