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

Yin Germaschewski, Jaroslav Horvath and Loris Rubini

Journal of International Economics, 2024, vol. 152, issue C

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.

Keywords: Debt elasticity of interest rate; Trend productivity shocks; Financial frictions; Macroeconomic volatility; Small open economy (search for similar items in EconPapers)
JEL-codes: E32 E44 F44 G15 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:152:y:2024:i:c:s002219962400117x

DOI: 10.1016/j.jinteco.2024.103990

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