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Introducing financial frictions and unemployment into a small open economy model

  • Christiano, Lawrence J.
  • Trabandt, Mathias
  • Walentin, Karl

Which are the main frictions and the driving forces of business cycle dynamics in an open economy? To answer this question we extend the standard new Keynesian model in three dimensions: we incorporate financing frictions for capital, employment frictions for labor and extend the model into a small open economy setting. We estimate the model on Swedish data. Our main results are that (i) a financial shock is pivotal for explaining fluctuations in investment and GDP. (ii) The marginal efficiency of investment shock has negligible importance. (iii) The labor supply shock is unimportant in explaining GDP and no high frequency wage markup shock is needed.

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File URL: http://www.sciencedirect.com/science/article/pii/S0165188911001710
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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 12 ()
Pages: 1999-2041

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:12:p:1999-2041
DOI: 10.1016/j.jedc.2011.09.005
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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