A time varying DSGE model with financial frictions
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We build a time varying DSGE model with financial frictions in order to evaluate changes in the responses of the macroeconomy to financial friction shocks. Using U.S. data, we find that the transmission of the financial friction shock to economic variables, such as output growth, has not changed in the last 30. years. The volatility of the financial friction shock, however, has changed, so that output responses to a one-standard deviation of the shock increase twofold in the 2007-2011 period in comparison with the 1985-2006 period. The time varying DSGE model with financial frictions improves the accuracy of forecasts of output growth and inflation during the tranquil period of 2000-2006, while delivering similar performance to the fixed coefficient DSGE model for the 2007-2012 period.
Galvão , A B , Giraitis , L , Kapetanios , G & Petrova , K 2016 , ' A time varying DSGE model with financial frictions ' Journal of Empirical Finance , vol 38 , no. B , pp. 690–716 . DOI: 10.1016/j.jempfin.2016.02.012
Journal of Empirical Finance
Copyright © 2016 Elsevier B.V. This work is made available online in accordance with publisher's policies. This is the author created, accepted version manuscript following peer review and may differ slightly from the final published version. The final published version is available at https://doi.org/10.1016/j.jempfin.2016.02.012
Galvão, Kapetanios and Petrova acknowledge fnancial support from the ESRC grant No ES/K010611/1.
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