Financial Frictions and Monetary Policy in Developing Economies: An Estimated DSGE Model with a Banking Sector for Morocco

Faical Lakhchen

International Economic Journal, 2025, vol. 39, issue 2, 400-422

Abstract: This paper examines how the presence of financial frictions in the banking sector amplify business cycle fluctuations in developing economies and the role of monetary policy in mitigating these fluctuations. Using a New Keynesian DSGE model, we compare versions with and without financial frictions. The model with frictions fits the data better and shows that these frictions magnify the impact of capital quality shocks, causing deeper and more prolonged downturns. We also explore implications for monetary policy, comparing standard inflation-targeting rules with those that include financial stability objectives. Results show that incorporating credit stabilization reduces volatility in inflation, output, and credit. These findings highlight the need for policies that account for financial frictions to better manage economic stability in developing economies.

Date: 2025
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DOI: 10.1080/10168737.2025.2459146

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