Introducing Financial Frictions and Unemployment into a Small Open Economy Model

Lawrence Christiano, Mathias Trabandt and Karl Walentin

No 214, Working Paper Series from Sveriges Riksbank (Central Bank of Sweden)

Abstract: Which are the main frictions and driving forces of business cycle dynamics in a small open economy? To answer this question we extend what is becoming the standard new Keynesian model in three dimensions. First, we incorporate frictions in the financing of the capital stock. Second, we model employment frictions in the labor market using a search and matching framework, allowing for endogenous job separations. Third, we extend the model into a small open economy setting. We estimate the model using Bayesian techniques on Swedish data. Our main results are: i) A financial shock to entrepreneurial wealth is pivotal for explaining business cycle fluctuations accounting for substantial amounts of the variance in investment and GDP. ii) The marginal efficiency of investment shock has very limited importance when we match financial market data. iii) Our model does not need any high frequency wage markup shocks to match the data. Furthermore, the labor supply shock is unimportant in explaining GDP. iv) The data indicates that there are costs of hiring, but no costs of vacancy postings per se.

Keywords: DSGE model; financial frictions; labor market frictions; unemployment; small open economy; Bayesian estimation. (search for similar items in EconPapers)
JEL-codes: E00 E30 F00 F40 G00 G10 J60 (search for similar items in EconPapers)
Pages: 83 pages
Date: 2007-11-01, Revised 2011-06-01
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Citations: View citations in EconPapers (326)

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Related works:
Journal Article: Introducing financial frictions and unemployment into a small open economy model (2011)
Working Paper: Introducing financial frictions and unemployment into a small open economy model (2010)
Working Paper: Introducing Financial Frictions and Unemployment into a Small Open Economy Model (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:rbnkwp:0214

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