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

University of Sassari; CRENOS Università di Cagliari e Sassari

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

University of Sassari ( email )

DEIR, Faculty of Economics
Via Torre Tonda 34
Sassari, 07100
Italy
00390792017333 (Phone)
00390792017312 (Fax)

CRENOS Università di Cagliari e Sassari ( email )

Facolta di Scienze Politiche via Sant'Ignazio 78
Cagliari, 09124
United States

HOME PAGE: http://www.aculaddied.it

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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