Rossana Merola

The Role of Financial Frictions During the Crisis: An Estimated DSGE Model

After the recent banking crisis in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. This paper provides a quantitative assessment of the impact of financial frictions on the U.S. business cycle. The analysis compares the original Smets and Wouters model (2003, 2007) with an alternative version augmented with the financial accelerator mechanism a la Bernanke, Gertler and Gilchrist (1996,1999). Both versions are estimated using Bayesian techniques over a sample extended to 2012. The analysis supports the role of financial channels, namely the financial accelerator mechanism, in transmitting dysfunctions from financial markets to the real economy. The Smets and Wouters model, augmented with the financial accelerator mechanism, is suitable to capture much of the historical developments in U.S. financial markets that led to the financial crisis. The model can account for the output contraction in 2008, as well as the widening in corporate spreads and supports the argument that financial conditions have amplified the U.S. business cycle and the intensity of the recession.

Optimal Monetary Policy in a Small Open Economy with Financial Frictions

I analyze how the introduction of financial frictions can affect the trade-off between output stabilization and inflation stability and whether, in the presence of financial frictions, the optimal outcome can be realized or approached more closely if monetary policy is allowed to react to aggregate financial variables. Moreover, I explore the issue of whether an inflation targeting cum exchange rate stabilization and a price-level targeting are more suitable rules in minimizing distortions generated by the presence of liabilities defined in foreign currency and in nominal terms. I find that, when the financial accelerator mechanism is working, a price-level targeting rule dominates. One caveat is that the source of the shock plays an important role. Once the financial shock is not operative, the gain from a price-level targeting rule decreases significantly.

A Bayesian Estimation of a DSGE Model with Financial Frictions

Episodes of crises that have recently plagued many emerging market economies have lead to a wide-spread questioning of the two traditional generations of models of currency crises. Distressed banking system and adverse credit-markets conditions have been pointed as sources of serious macroeconomics contractions, so introducing these imperfections into standard economic models can help to explain the more recent crises. This paper introduces financial frictions a la Bernanke Gertler and Gilchrist in a two-sector small open economy, suited to analyze an emerging country. The model is estimated on simulated data applying both Bayesian techniques and maximum likelihood method and comparing the results under the two di¤erent estimation procedures. First, I analyze the influence of the prior on the estimation outcomes. Results seems to confirm that one of the main advantages of Bayesian approach is the ability of providing a framework for evaluating fundamentally mis-specified models. Second, I test the sensitivity of estimation outcomes to the sample size, showing how, for large samples, results under Bayesian estimation converges asymptotically to those obtained applying maximum likelihood. A further extension would be to perform the estimation on historical data for an emerging economy that have recently experienced a financial crisis.