Premio Anual de Investigación Económica “Dr. Raúl Prebisch”

Macroeconomics and Financial Dynamics in Small Open Economies

Javier García-Cicco

2016-03-17 - The goal of this paper is to explore which financial frictions are more useful in explaining the joint dynamics of macroeconomic and credit-related variables in a small open economy. In particular, we set up a DSGE model of a small open economy featuring two types of financial frictions: one in the relationship between depositors and banks (as in Gertler and Karadi, 2011) and the other between banks and borrowers (along the lines of Bernanke et al., 1999). We use Chilean data to estimate the model, following a Bayesian approach. We emphasize several findings. First, the presence of both frictions is quite useful in matching the dynamics of observed macro and financial variables, as well as their co-movement. Second, we find that the friction related to borrowers’ risk is the relatively more relevant in explaining the behavior of both financial and nonfinancial variables, compared to the one associated with the banking problem. Finally, we assess how the presence of financial frictions change the propagation of the main driving forces of the economy.