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The Equity Price Channel in a New-Keynesian DSGE Model with Financial Frictions and Banking

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  • Hylton Hollander and Guangling Liu

Abstract

This paper studies the role of the equity price channel in business cycle fluctuations, and highlights its systemic risk across all sectors of the economy. We develop a canonical New-Keynesian dynamic stochastic general equilibrium model with a tractable role for the equity market in banking, entrepreneur and household economic interactions. The model is estimated with Bayesian techniques using U.S. data over the sample period 1982Q01 - 2012Q01. We show that a New-Keynesian DSGE model with an equity price channel well mimics the U.S. business cycle. Moreover, the equity price channel significantly exacerbates business cycle fluctuations through both the financial accelerator and bank funding channels. This study highlights the equity price channel as a different aspect to general equilibrium models with financial frictions, and emphasizes the consequences of the (in)stability of financial markets on the real economy.

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Bibliographic Info

Paper provided by Economic Research Southern Africa in its series Working Papers with number 360.

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Length: 30 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:rza:wpaper:360

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Keywords: Equity price channel; asset pricing; financial frictions; bank capital; New-Keynesian; Bayesian;

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References

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  1. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  2. Harald Uhlig, 2007. "Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model," SFB 649 Discussion Papers SFB649DP2007-003a, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  4. Efrem Castelnuovo & Salvatore Nisticò, 2010. "Stock Market Conditions and Monetary Policy in a DSGE Model for the U.S," "Marco Fanno" Working Papers 0107, Dipartimento di Scienze Economiche "Marco Fanno".
  5. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6112, C.E.P.R. Discussion Papers.
  6. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers, Bank of Canada 08-36, Bank of Canada.
  7. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1999. "Habit persistence, asset returns and the business cycles," Working Paper Series, Federal Reserve Bank of Chicago WP-99-14, Federal Reserve Bank of Chicago.
  8. Gregory deWalque & Olivier Pierrard & Abdelaziz Rouabah, 2010. "Financial (In)Stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 120(549), pages 1234-1261, December.
  9. Andrea Gerali & Stefano Neri & Luca Sessa & Federico M. Signoretti, 2010. "Credit and banking in a DSGE model of the euro area," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 740, Bank of Italy, Economic Research and International Relations Area.
  10. Matteo Iacoviello & Stefano Neri, 2008. "Housing market spillovers : evidence from an estimated DSGE model," Working Paper Research, National Bank of Belgium 145, National Bank of Belgium.
  11. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 95(3), pages 739-764, June.
  12. Michał Brzoza-Brzezina & Marcin Kolasa & Krzysztof Makarski, 2011. "The anatomy of standard DSGE models with financial frictions," National Bank of Poland Working Papers, National Bank of Poland, Economic Institute 80, National Bank of Poland, Economic Institute.
  13. Bojan Markovic, 2006. "Bank capital channels in the monetary transmission mechanism," Bank of England working papers 313, Bank of England.
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Cited by:
  1. Federico GIRI, 2014. "Does Interbank Market Matter for Business Cycle Fluctuation? An Estimated DSGE Model with Financial Frictions for the Euro Area," Working Papers, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali 398, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.

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