Research Discussion Papers, Bank of Finland
No 1/2011:
Financial factors in the boom-bust episode in Finland in the late 1980s and early 1990s
Hanna Freystätter ()
Abstract: This paper proposes a framework for studying the boom and
bust in Finland in the late 1980s and early 1990s. We develop a small open
economy DSGE model with balance sheet-constrained firms ā la BGG and
calibrate it to the Finnish economy. We use the model to simulate three
events that are claimed to have played a key role in the Finnish boom-bust
episode and compare the model outcome with actual Finnish data. Firstly, we
assess in our DSGE framework the role of financial market deregulation in
the 1980s in the boom that preceded the crises. Secondly, we use our model
to evaluate the negative impact of the collapse of Soviet-Finnish trade at
the beginning of 1991. Thirdly, we investigate the effect of the collapse
of the fixed exchange rate regime in September 1992. We conclude that
financial frictions combined with the shocks that hit the Finnish economy
are able to produce a boom and a severe depression similar to the one
observed in Finland in the late 1980s and early 1990s. A key finding is the
crucial role played by the financial accelerator mechanism in the ability
of the model to mimic the response of the Finnish economy to the shocks it
encountered. A key contribution is the incorporating unconventional shocks
into the model: domestic financial market shocks to capture the
deregulation of the financial market; a capital obsolescence shock to model
the sudden redundancy of Soviet-oriented manufacturing; and a shock from
the international financial market, a country borrowing premium shock, to
capture the collapse of the fixed exchange rate regime.
Keywords: depression; Finland; financial factors; DSGE models; (follow links to similar papers)
JEL-Codes: E27; E32; E44; (follow links to similar papers)
42 pages, February 4, 2011
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