Financial frictions in DSGE models

(eng) After the banking crises experienced by many countries in the 1990s and in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. As a consequence, the financial accelerator approach has become wide-spread in the literature and many studies have introduced this type of frictions in DSGE models. This thesis deals with the role played by financial frictions in the transmission of macroeconomic shocks. I introduce financial frictions in DSGE models following the approach initially introduced by Bernanke and Gertler (1989) and then further developed by Bernanke, Gertler and Gilchrist (1996, 1999) and Carlstrom and Fuerst (1997). Chapter 2 and chapter 3 are theoretical: they are based on a calibrated model and they mainly explore the implications of financial frictions for macroeconomic policies. Chapter 4, instead, is empirical, as it presents a Bayesian estimation on U.S. historical data up to 2010, based on the Smets and Wouters (2004, 2007) model augmented with financial frictions.Chapter 2 introduces financial frictions in a closed economy and assesses the implications of the zero lower bound in a DSGE model with financial frictions. This chapter contributes to the debate on whether monetary policy is effective when the nominal interest rate is close to zero and whether, in this case, fiscal stimulus might may help in rebounding the economy from the recession. The analysis in this chapter shows that in a framework of financial instability, when the interest rate is lower-bounded, the initial impact of a negative shock is amplified and the economy is more likely to plunge into a recession. I find that the monetary authority might alleviate the recession by targeting the price-level. Fiscal stimulus represents an alternative solution especially when the zero lower bound constraint becomes binding, as fiscal multipliers may become larger than one. In analyzing discretionary fiscal policy, this chapter does also focus on two crucial aspects: the duration of the fiscal stimulus and the presence of implementation lags. Chapter 3 moves a step forward and contributes to the existing literature by extending the financial accelerator mechanism à la Bernanke, Gertler and Gilchrist (1996, 1999) to an open economy setting with debt denominated in foreign currency and in nominal terms. The chapter assesses the performance of alternative Taylor rules. I show that, in the presence of financial frictions in the form of borrowing constraint and nominal liabilities denominated in foreign currency, a simple Taylor rule targeting inflation and output gap is not able to realize output stabilization and inflation stability at the same time. Therefore, I assess whether the optimal outcome can be approached more closely if monetary policy is allowed to react to a broader (or different) set of variables. I find that a price-level targeting rule dominates, while adding financial variables or exchange rate in the Taylor rule does not improve macroeconomic stability. A price-level targeting rule results to dominate through the mitigation of the uncertainty surrounding the real value of not-fully indexed liabilities, rather than through the control of agents' expectations. Once the financial shock is not operative, the gain from a price-level targeting rule decreases Chapter 4 investigates whether frictions in financial markets have become more important for business cycles especially during the recent financial crisis, even if realistic frictions in goods and labour markets are added to a model with frictions in financial markets. To this purpose, I extend the Smets and Wouters model by adding financial frictions à la Bernanke, Gertler, and Gilchrist (1996). I estimate the model using the same seven key macroeconomic time series for the U.S. economy used in the SW model and applying Bayesian methods. This chapter contributes to this debate in three respects. First, I assess the influence of the great recession on estimates results. The comparison between estimates up to 2010 with those based on the sample up to 2004 proves that the recent crisis has amplified the role of financial factors. Second, I check the relevance of the financial accelerator mechanism. Estimation results conclude that financial factors have enhanced the relevance of financial-type shocks in driving economic fluctuations. Third, I identify the shocks that are responsible for the financial crisis and are accounted as the key sources of economic fluctuations. In this respect, I demonstrate that leverage and credit have played an important role in shaping the business cycle. Beside on this empirical evidence, this chapter draws policy recommendations in favour of a more prudential regulation of financial markets. Moreover, results help interpreting movements in the premium in relation to shocks driving the business cycle and are in line with the events that started with the subprime crisis in the summer 2007 and triggered the financial crisis.