Introducing Financial Frictions and Unemployment into a Small Open Economy Model

Abstract

The current …nancial crisis has made it abundantly clear that business cycle modeling no longer can abstract from …nancial factors. It is also becoming increasingly clear that the stylized modeling of labor markets without explicit unemployment that is the current standard approach has its limitations. Some questions which the dominating extant business cycle models are mute on, but that we would like to answer are: How important are …nancial and labor market frictions for the business cycle dynamics of a small open economy? In particular, what are the quantitative e¤ects of …nancial factors on output and in ‡ation, and how do they interact with monetary policy? What drives the variation in the intensive and extensive margin of labor supply respectively? What is the estimated Frisch elasticity in a model that allows for both an intensive and an extensive margin of labor supply? In order to address these questions we extend what is becoming the standard new Keynesian model in three important dimensions. First, we incorporate …nancial frictions in the accumulation and management of capital. Second, we model the labor market using a search and matching framework. Third, we extend the model into a small open economy setting. We make a theoretical contribution by incorporating endogenous job separation in this rich framework. Finally, we estimate the full model using Bayesian techniques and illustrate the importance of the various frictions.

Land-Price Dynamics and Macroeconomic Fluctuations

“…In recent papers, Christiano, Trabandt, and Walentin (2007) and Christiano, Motto, and Rostagno (2010) build on BGG and examine the empirical importance of the financial accelerator using time series data from the United States and the euro area. Gilchrist, Ortiz, and Zakrajsek (2009) examine the importance of credit spread for macroeconomic fluctuations by fitting a version of the BGG model to a measure of credit spread constructed with microlevel data, following the approach in Gilchrist, Yankov, and Zakrajsek (2009).…”

Asset Prices and Macroeconomic Outcomes: A Survey

“…On the one hand, devaluation can lead to an increase in the 34 See Corsetti (2008) for a review of DSGE models. See also Woodford (2010b) and Christiano et al (2011a) for an open economy model incorporating financial frictions. 35 See, among others, chapters in Volume 3 of the Handbook for International Economics (Grossman and Rogoff (eds) (1995)) and Volume 4 (Gopinath et al (eds) (2014)).…”

Land Prices and Unemployment

“…The recent literature on labor-market frictions is also too large to list exhaustively. Examples are Gertler et al (2008), Gertler and Trigari (2009), Lubik (2009), Blanchard and Galí (2010, Justiniano and Michelacci (2011), Christiano et al (2011), Galí et al (2012, and Christiano et al (2013). Recent studies on potential links between financial factors and unemployment fluctuations include Davis et al (2010), Hall (2011b), Monacelli et al (2011), Petrosky-Nadeau and Wasmer (2013), Petrosky-Nadeau (2014), and Miao et al (2015).…”