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How important are trend shocks? The role of the debt elasticity of interest rate

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  • Germaschewski, Yin
  • Horvath, Jaroslav
  • Rubini, Loris

Abstract

We study how financial frictions affect the importance of trend productivity shocks for macroeconomic fluctuations. Using long-run data from 17 small open economies (SOEs), we compare two variants of a workhorse SOE real business cycle model featuring a debt-elastic interest rate (DEIR), a measure of financial frictions. The first variant estimates the DEIR parameter, while the second fixes it to 0.001, effectively abstracting from financial frictions. On average, ignoring financial frictions doubles the contribution of trend shocks to output fluctuations. This suggests that a proper assessment of the quantitative effects of trend shocks requires reasonable DEIR values.

Suggested Citation

  • Germaschewski, Yin & Horvath, Jaroslav & Rubini, Loris, 2024. "How important are trend shocks? The role of the debt elasticity of interest rate," Journal of International Economics, Elsevier, vol. 152(C).
    • Handle: RePEc:eee:inecon:v:152:y:2024:i:c:s002219962400117x
    DOI: 10.1016/j.jinteco.2024.103990
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    More about this item

    Keywords

    Debt elasticity of interest rate; Trend productivity shocks; Financial frictions; Macroeconomic volatility; Small open economy;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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