THE ROLE OF FOREIGN DEBT AND FINANCIAL FRICTIONS IN A SMALL OPEN ECONOMY DSGE MODEL

2016 ◽  
Vol 61 (05) ◽  
pp. 1550077
Author(s):  
MYUNG-SOO YIE ◽  
BYOUNG HARK YOO
Keyword(s):  
Business Cycle ◽  
Open Economy ◽  
Risk Premium ◽  
Financial Frictions ◽  
Foreign Debt ◽  
Small Open Economy ◽  
State Level ◽  
Korean Economy ◽  
Dynamic Stochastic

We examine the role of foreign debt and financial frictions in the Korean business cycle using a small open economy DSGE (dynamic stochastic general equilibrium) model where domestic banks borrow external funds, denominated in foreign currencies, for a risk premium and make loans to domestic producers. We find that the Korean economy is ‘financially vulnerable’, which means that the risk premium increases when the domestic currency depreciates. As a result, depreciation could cause recession, rather than expansion, when there exist substantial amount of foreign debt or financial frictions. A simulation shows that the Korean business cycle would suffer less volatility with a lower steady-state level of foreign debt or no financial frictions.

scholarly journals The Vietnamese business cycle in an estimated small open economy New Keynesian DSGE model

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Phuong V. Nguyen
Keyword(s):  
Business Cycle ◽  
Open Economy ◽  
Small Open Economy ◽  
Research Paper ◽  
New Keynesian ◽  
Dsge Model ◽  
Content Type ◽  
Business Cycle Fluctuations ◽  
Dynamic Stochastic ◽  
The Business Cycle

PurposeThe primary purpose of this paper is to investigate the sources of the business cycle fluctuations in Vietnam. To this end, the author develops a small open economy New Keynesian dynamic stochastic general equilibrium (SOE-NK-DSGE) model. Accordingly, this model includes various features, such as habit consumption, staggered price, price indexation, incomplete exchange-rate pass-through (ERPT), the failures of the law of one price (LOOP) and the uncovered interest rate parity. It is then estimated by using the Bayesian technique and Vietnamese data 1999Q1–2017Q1. Based on the estimated model, this paper analyzes the sources of the business cycle fluctuations in this emerging economy. Indeed, this research paper is the first attempt at developing and estimating the SOE-NK-DSGE model with the Bayesian technique for Vietnam.Design/methodology/approachA SOE-NK-DSGE model—Bayesian estimation.FindingsThis paper analyzes the sources of the business cycle fluctuations in Vietnam.Originality/valueThis research paper is the first attempt at developing and estimating the SOE-NK-DSGE model with the Bayesian technique for Vietnam.

scholarly journals Interest Rates, Leverage, and Business Cycles in Emerging Economies: The Role of Financial Frictions

2015 ◽  
Vol 7 (3) ◽  
pp. 153-188 ◽  
Author(s):  
Andrés Fernández ◽  
Adam Gulan
Keyword(s):  
Business Cycles ◽  
Interest Rates ◽  
Open Economy ◽  
Emerging Economies ◽  
Financial Frictions ◽  
Small Open Economy ◽  
Financial Data ◽  
Cycle Model ◽  
Business Cycle Model

Countercyclical country interest rates have been shown to be an important characteristic of business cycles in emerging markets. In this paper we provide a microfounded rationale for this pattern by linking interest rate spreads to the dynamics of corporate leverage. For this purpose we embed a financial accelerator into a business cycle model of a small open economy and estimate it on a novel panel dataset for emerging economies that merges macroeconomic and financial data. The model accounts well for the empirically observed countercyclicality of interest rates and leverage, as well as for other stylized facts. (JEL E13, E32, E43, E44, F41, O11)

scholarly journals Labor Market Informality and the Business Cycle

2020 ◽  
Vol 20 (256) ◽  
Author(s):  
Frederic Lambert ◽  
Andrea Pescatori ◽  
Frederik Toscani
Keyword(s):  
Labor Market ◽  
Business Cycle ◽  
Open Economy ◽  
Developing Economies ◽  
Small Open Economy ◽  
Gdp Per Capita ◽  
Formal Sector ◽  
Cycle Frequency ◽  
Dynamic Stochastic ◽  
Per Capita

Labor market informality is a pervasive feature of most developing economies. Motivated by the empirical regularity that the labor informality rate falls with GDP per capita, both at business cycle frequency and in a cross-section of countries, and that the Okun's coefficient falls with the level of labor informality, we build a small open-economy dynamic stochastic general equilibrium model with two sectors, formal and informal, which can replicate these key stylized facts. The model is calibrated to Colombia. The results show that labor market and tax reforms play an important role in changing the informality rate but also caution against over-optimism - with low GDP per capita, informality will always be relatively high as there is insufficient demand for formal goods. Quantitatively we find that higher productivity in the formal sector is key in explaining the difference between Colombia and countries with significantly lower informality. We use the model to study how labor informality and labor market frictions mediate the cyclical response of the economy to shocks, including commodity price shocks which are particularly relevant in Latin America. Informality is shown to play an important role as a shock absorber with the informal-formal margin limiting movements in the employed-unemployed margin.

Welfare Effect of Productivity Shocks and Policy Implications in a Small Open Economy

2012 ◽  
Vol 11 (2) ◽  
pp. 290-319 ◽  
Author(s):  
Richard E. Ericson ◽  
Xuan Liu
Keyword(s):  
Business Cycle ◽  
Open Economy ◽  
Policy Implication ◽  
Financial Frictions ◽  
Small Open Economy ◽  
Welfare Effect ◽  
Policy Implications ◽  
Real Business Cycle ◽  
Productivity Shocks

Abstract We examine the welfare effect and policy implications of productivity shocks in a small open economy. With real business cycle models, productivity shocks are generally welfare improving. However, once we assign a big role to financial frictions, productivity shocks may become welfare deteriorating. These results are robust. Moreover, the policy implication hinges on preferences, policy specifications, and financial frictions.

scholarly journals Three essays on bayesian analysis of nonlinear DSGE models

2019 ◽  
Author(s):  
◽  
Sanha Noh
Keyword(s):  
Decision Making ◽  
Linear Model ◽  
Open Economy ◽  
Financial Frictions ◽  
Small Open Economy ◽  
Dsge Models ◽  
Dsge Model ◽  
Productivity Shock ◽  
Dynamic Stochastic ◽  
The Impact

The 2008 financial crisis has highlighted the importance of nonlinear features of our economy including risks, uncertainty shocks, rare disasters, structural changes, zero-lower bound, and occasionally binding constraints. Macroeconomists have tried to build nonlinear models to analyze these interesting features and take the models to the data. Dynamic Stochastic General Equilibrium (DSGE) model that essentially takes into account dynamic optimal decision making of households, firms, and government is one of the useful tools to deal with these issues. In the model, there are various random shocks causing the macroeconomic variables such as GDP, consumption, and investment to fluctuate over time. Above all things, the nonlinear approximation of the model allows us to capture the impact of risk on decision making. The focus of this dissertation is to provide a novel Bayesian estimation procedure for the estimation of nonlinear DSGE model and apply the proposed methodologies to analyze some nonlinear issues related to DSGE models. ... In the third chapter, I investigate a real business cycle (RBC) model for a small open economy by estimating the model solved up to second order. The higher order approximation more closely approximates the original model than the linear approximation. In this study, I evaluate the likelihood of the nonlinear model using the Gaussian mixture a lter (GMF) and employ the GMF within the MCMC algorithm. From the estimation results of the quadratic approximation, I obtain the following implications for a small open economy: First, the quadratic RBC model with financial frictions does a good job at identifying the parameters of the nonstationary productivity shock process. Second, the observed data favor the quadratic benchmark RBC and financial-friction models over the linear models. Third, the quadratic RBC model with financial frictions does a better job at capturing serial correlations of the observed data than the linear model with financial frictions. Fourth, contrary to the linear model with financial frictions, a nonstationary productivity shock in the quadratic model plays an important role in explaining Argentine economic fluctuations.

scholarly journals Informality, Frictions, and Macroprudential Policy

2019 ◽  
Vol 2019 (255) ◽  
Author(s):  
Moez Ben Hassine ◽  
Nooman Rebei
Keyword(s):  
Open Economy ◽  
Inflation Targeting ◽  
Banking Sector ◽  
Financial Frictions ◽  
Small Open Economy ◽  
Dynamic Stochastic General Equilibrium ◽  
Macroprudential Policy ◽  
Macroprudential Policies ◽  
Labor Search ◽  
Dynamic Stochastic

We analyze the effects of macroprudential policies through the lens of an estimated dynamic stochastic general equilibrium (DSGE) model tailored to developing markets. In particular, we explicitly introduce informality in the labor and goods markets within a small open economy embedding financial frictions, nominal and real rigidities, labor search and matching, and an explicit banking sector. We use the estimated version of the model to run welfare analysis under optimized monetary and macroprudential rules. Results show that although informality reduces the efficiency of macroprudential policies following a convex fashion, combining the latter with an inflation targeting objective could be beneficial.

The long-run stability of a small, open economy under crawling peg regime

2002 ◽  
Vol 52 (1) ◽  
pp. 57-78
Author(s):  
S. Çiftçioğlu
Keyword(s):  
Exchange Rate ◽  
Open Economy ◽  
Risk Premium ◽  
Small Open Economy ◽  
Exchange Rate Policy ◽  
Price Stability ◽  
Output Stability ◽  
Long Run ◽  
The Exchange Rate ◽  
The Impact

The paper analyses the long-run (steady-state) output and price stability of a small, open economy which adopts a “crawling-peg” type of exchange-rate regime in the presence of various kinds of random shocks. Analytical and simulation results suggest that with the exception of money demand shocks, an exchange rate policy which involves a relatively higher rate of indexation of the exchange rate to price level is likely to lead to the worsening of price stability for all types of shocks. On the other hand, the impact of adopting such a policy on output stability depends on the type of the shock; for policy shocks to the exchange rate and shocks to output demand, output stability is worsened whereas for the shocks to risk premium of domestic assets, supply price of domestic output and the wage rate, better output stability is achieved in the long run.

Financial openness, bank capital flows, and the effectiveness of macroprudential policies

2021 ◽  
pp. 1-32
Author(s):  
Hao Jin ◽  
Chen Xiong
Keyword(s):  
Open Economy ◽  
Capital Flows ◽  
Open Economies ◽  
Small Open Economy ◽  
Empirical Support ◽  
Bank Capital ◽  
Macroprudential Policy ◽  
Funding Sources ◽  
Macroprudential Policies ◽  
Dynamic Stochastic

Abstract This paper quantitatively examines the macroeconomic and welfare effects of macroprudential policies in open economies. We develop a small open economy dynamic stochastic general equilibrium (DSGE) model, where banks choose their funding sources (domestic vs. foreign deposits) and are subject to financial constraints. Our model predicts that banks reduce leverage in response to a macroprudential policy tightening, but increasingly rely on foreign funding. This endogenous shifts of funding composition significantly undermine the stabilizing effect and welfare gains of macroprudential policies. Our results also suggest macroprudential policies are less effective in financially more open economies, and optimal policy should take capital flows into consideration. Finally, we find empirical support for the model predictions in a group of developing and emerging economies.

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