Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 738: How Important are Financial Frictions in the U.S. and Euro Area?

Virginia Queijo ()
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Virginia Queijo: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden

Abstract: This paper aims to evaluate the importance of frictions in credit markets for business cycles in the U.S. and the Euro area. For this purpose, I modify the DSGE financial accelerator model developed by Bernanke, Gertler and Gilchrist (1999) and estimate it using Bayesian methods. The model is augmented with frictions such as price indexation to past inflation, sticky wages, consumption habits and variable capital utilization. My results indicate that financial frictions are relevant in both areas. Using the Bayes factor as criterion, the data favors the model with financial frictions both in the U.S. and the Euro area in five different specifications of the model. Moreover, the size of the financial frictions is larger in the Euro area.

Keywords: DSGE models; Bayesian estimation; financial accelerator

JEL-codes: C11; C15; E32; E40; E50; G10

51 pages, August 1, 2005

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