Financial Frictions in the Small Open Economy

Jae-Hun Shim

Research output: Working paper

Abstract

This paper introduces a global banking system in a small open economy DSGE model with financialfrictions. The model features global relative price adjustments with incomplete asset market. Three mainfindings stand out. Firstly, foreign financial shocks capture negative spillovers from foreign country ina global financial crisis. We show that country differences in the severity of the shocks depend on thedegree of trade openness and banking system stability. Secondly, credit policy could be more powerfulthan monetary policy to alleviate foreign financial shocks since an expansionary monetary policy andalternative policy rules are not a sufficient tool in the global financial crisis. In particular, credit policybased on international credit spread outperforms credit policy based on domestic credit spread since thelatter leads to “excess smoothness” in the real exchange rate. Lastly, foreign credit policy has a negligibleinfluence on domestic welfare so that the small open economy can effectively reduce welfare losses onlyif the central bank in the economy injects credit.
LanguageEnglish
Place of PublicationBath, U. K.
PublisherDepartment of Economics, University of Bath
StatusPublished - Jun 2016

Publication series

NameBath Economics Research Working Papers

Fingerprint

Financial frictions
Small open economy
Credit policy
Credit spreads
Global financial crisis
Financial shocks
Banking system
Monetary policy
Credit
Incomplete asset markets
Price adjustment
Relative prices
Severity
Trade openness
DSGE models
Spillover
Country differences
Central bank
Real exchange rate
Welfare loss

Cite this

Shim, J-H. (2016). Financial Frictions in the Small Open Economy. (Bath Economics Research Working Papers). Bath, U. K.: Department of Economics, University of Bath.

Financial Frictions in the Small Open Economy. / Shim, Jae-Hun.

Bath, U. K. : Department of Economics, University of Bath, 2016. (Bath Economics Research Working Papers).

Research output: Working paper

Shim, J-H 2016 'Financial Frictions in the Small Open Economy' Bath Economics Research Working Papers, Department of Economics, University of Bath, Bath, U. K.
Shim J-H. Financial Frictions in the Small Open Economy. Bath, U. K.: Department of Economics, University of Bath. 2016 Jun, (Bath Economics Research Working Papers).
Shim, Jae-Hun. / Financial Frictions in the Small Open Economy. Bath, U. K. : Department of Economics, University of Bath, 2016. (Bath Economics Research Working Papers).
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