| Abstract: |
In the last few years, macroeconomic modelling has emphasised the role of
credit market frictions in magnifying and transmitting nominal and real
disturbances and their implication for macro-prudential policy design. In this
paper, we construct a modest New Keynesian general equilibrium model with
active banking sector. In this set-up, the financial sector interacts with the
real side of the economy via firm balance sheet and bank capital conditions
and their impact on investment and production decisions. We rely on the
financial accelerator mechanism due to Bernanke et al. (1999) and combine it
with a bank capital channel as demonstrated by Aguiar and Drumond (2007). We
calibrate the resulting model from the perspective of a low income economy
reflecting the existence of relatively high investment adjustment cost, strong
fiscal dominance, and underdeveloped financial and capital markets where the
central bank uses money growth in stabilizing the national economy. Then we
examine the impulse response of selected endogenous variables to shocks
stemming from the fiscal authority, the monetary policy process, and
technological progress. The findings are broadly consistent with previous
studies that demonstrated stronger role for credit market imperfections in
amplifying and propagating monetary policy shocks. Moreover, we also compare
the trajectory of the model economy under alternative monetary policy
instruments. The results suggest that the model with money growth rule
generates higher volatility in output and inflation than the one with interest
rate rule. |