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Financial factors in economic fluctuations

  • Christiano, Lawrence
  • Rostagno, Massimo
  • Motto, Roberto

We augment a standard monetary DSGE model to include a banking sector and financial markets. We fit the model to Euro Area and US data. We find that agency problems in financial contracts, liquidity constraints facing banks and shocks that alter the perception of market risk and hit financial intermediation — ‘financial factors’ in short — are prime determinants of economic fluctuations. They have been critical triggers and propagators in the recent financial crisis. Financial intermediation turns an otherwise diversifiable source of idiosyncratic economic uncertainty, the ‘risk shock’, into a systemic force. JEL Classification: E3, E22, E44, E51, E52, E58, C11, G1, G21, G3

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Paper provided by European Central Bank in its series Working Paper Series with number 1192.

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Date of creation: May 2010
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Handle: RePEc:ecb:ecbwps:20101192
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