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Financial frictions in a DSGE model for Latvia

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  • Buss, Ginters

Abstract

This paper builds a dynamic stochastic general equilibrium (DSGE) model for Latvia that would be suitable for policy analysis and forecasting purposes at Bank of Latvia. For that purpose, I adapt the DSGE model with financial frictions of Christiano, Trabandt and Walentin (2011) to Latvia’s data, estimate it, and study whether adding the financial frictions block to an otherwise identical (‘baseline’) model is an improvement with respect to several dimensions. The main findings are: i) the addition of financial frictions block provides more appealing interpretation for the drivers of economic activity, and allows to reinterpret their role; ii) financial frictions played an important part in Latvia’s 2008-recession; iii) the financial frictions model beats both the baseline model and the random walk model in forecasting both CPI inflation and GDP, and performs roughly the same as a Bayesian structural vector autoregression.

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  • Buss, Ginters, 2015. "Financial frictions in a DSGE model for Latvia," Dynare Working Papers 42, CEPREMAP.
    • Handle: RePEc:cpm:dynare:042
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    1. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    3. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2008. "Evaluating an estimated new Keynesian small open economy model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2690-2721, August.
    4. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    6. Adjemian, Stéphane & Bastani, Houtan & Juillard, Michel & Karamé, Fréderic & Maih, Junior & Mihoubi, Ferhat & Mutschler, Willi & Perendia, George & Pfeifer, Johannes & Ratto, Marco & Villemot, Sébasti, 2011. "Dynare: Reference Manual Version 4," Dynare Working Papers 1, CEPREMAP, revised Mar 2021.
    7. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2011. "Investment Shocks and the Relative Price of Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(1), pages 101-121, January.
    8. Christiano, Lawrence J. & Trabandt, Mathias & Walentin, Karl, 2011. "Introducing financial frictions and unemployment into a small open economy model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 1999-2041.
    9. Robert Stehrer, 2013. "Accounting Relations in Bilateral Value Added Trade," wiiw Working Papers 101, The Vienna Institute for International Economic Studies, wiiw.
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    Cited by:

    1. Ginters Buss, 2015. "Search-and-Matching Frictions and Labour Market Dynamics in Latvia," Working Papers 2015/04, Latvijas Banka.
    2. Aliaga, Augusto, 2020. "Reglas de política monetaria para una economía abierta con fricciones financieras: Un enfoque Bayesiano [Monetary policy rules for an open economy with financial frictions: A Bayesian approach]," MPRA Paper 100604, University Library of Munich, Germany.
    3. Aliaga Miranda, Augusto, 2020. "Monetary policy rules for an open economy with financial frictions: A Bayesian approach," Dynare Working Papers 62, CEPREMAP.
    4. De La Peña, Rogelio & García, Ignacio, 2023. "Untangling crises: GFC and COVID-19 through the lens of a DSGE model," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 4(2).
    5. Shobande Olatunji Abdul & Shodipe Oladimeji Tomiwa, 2019. "New Keynesian Liquidity Trap and Conventional Fiscal Stance: An Estimated DSGE Model," Economics and Business, Sciendo, vol. 33(1), pages 152-169, January.

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    More about this item

    Keywords

    DSGE model; financial frictions; small open economy; Bayesian estimation; Currency union;
    All these keywords.

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • F0 - International Economics - - General
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets

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