Business Cycle and Monetary Policy Analysis with Market Rigidities and Financial Frictions

39 Pages Posted: 7 Mar 2013

See all articles by Miguel Casares

Miguel Casares

Universidad Pública de Navarra

Luca Deidda

Università degli Studi di Sassari - Department of Economics and Business; Universita di Cagliari - Centre for North South Economic Research (CRENOS)

Jose E. Galdon-Sanchez

Universidad Publica de Navarra ; IZA

Date Written: March 5, 2013

Abstract

We examine business cycle fluctuations in a dynamic macroeconomic model that incorporates a financial accelerator mechanism, borrowing constraints, and frictions on both setting prices and wages. After an adverse financial shock, the slow-adjustment process on wage cuts results in higher production marginal costs, lower firm earnings, and a subsequent reduction in equity that explains the increase in the cost of borrowing and the credit crunch. The real effects of adverse financial shocks are significantly amplified when either considering greater rigidities for price/wage setting or a low elasticity of substitution in loan production (real rigidities in the financial sector). In the monetary policy analysis, a Taylor (1983)-style rule performs slightly better when incorporating a small response coefficient to the spread between borrowing and saving interest rates.

Keywords: financial accelerator, nominal rigidities, real rigidities

JEL Classification: E32, E44

Suggested Citation

Casares, Miguel and Deidda, Luca and Galdon-Sanchez, Jose E., Business Cycle and Monetary Policy Analysis with Market Rigidities and Financial Frictions (March 5, 2013). Available at SSRN: https://ssrn.com/abstract=2228699 or http://dx.doi.org/10.2139/ssrn.2228699

Miguel Casares

Universidad Pública de Navarra ( email )

Departamento de Economía
31006 Pamplona
Spain

Luca Deidda

Università degli Studi di Sassari - Department of Economics and Business ( email )

via Muroni 25
Sassari, Sassari 07100
Italy

Universita di Cagliari - Centre for North South Economic Research (CRENOS) ( email )

Italy

Jose E. Galdon-Sanchez (Contact Author)

Universidad Publica de Navarra ( email )

Department of Economics
Campus de Arrosadia
Pamplona, Navarra 31006
Spain
+34 948 16 9338 (Phone)
+34 948 16 97 21 (Fax)

HOME PAGE: http://www.econ.unavarra.es/~galdon/

IZA

P.O. Box 7240
Bonn, D-53072
Germany

HOME PAGE: http://www.iza.org/en/webcontent/personnel/photos/index_html?key=1494

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