Financial Factors: Implications for Output Gaps

IMF Working Papers, July 14, 2015

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Financial Factors: Implications for Output Gaps

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Bibliographic details

• Authors: Pau Rabanal, Marzie Taheri Sanjani
• Published: July 14, 2015
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781513512860.001

Summary

• New approach for analyzing the role of financial variables and shocks in computing the output gap.
• Estimated a two-region DSGE model for the euro area, with financial frictions at the household level, between 2000-2013.
• After joining the monetary union, a decline in some countries’ borrowing costs contributed to a credit, housing and real boom and bust cycle.
• Financial frictions amplified economic fluctuations and the measure of the output gap in those countries.
• In countries such as France and Germany, financial frictions played a minor role in output gap measures.
• Evidence of the trade-offs faced by the European Central Bank when trying to stabilize two regions in a currency union with unsynchronized economic cycles.

Methodology and empirical setup

• Model: two-region DSGE model for the euro area.
• Frictions modeled: financial frictions at the household level.
• Sample period: 2000-2013.
• Estimation approach: Bayesian Estimation (keyword from source).

Key findings

• Decline in borrowing costs after joining the monetary union was a contributing factor to:
  • credit booms,
  • housing booms,
  • real boom and bust cycles.
• Financial frictions amplified:
  • economic fluctuations,
  • measured output gaps in affected countries.
• Heterogeneity across countries:
  • Financial frictions had a large amplifying role in some countries.
  • Financial frictions played a minor role in output gap measures in France and Germany.
• Monetary policy trade-offs:
  • The European Central Bank faces trade-offs in stabilizing two regions within a currency union when economic cycles are unsynchronized.

Policy implications and recommendations

• Incorporate financial variables and shocks explicitly when computing output gaps for countries with significant financial booms and busts.
• Recognize cross-country heterogeneity within a monetary union; a one-size-fits-all monetary policy can involve trade-offs when regions are unsynchronized.
• Account for household-level financial frictions in macroeconomic models used for policy assessment in the euro area.

Subjects and keywords (as listed)

• Subjects: Housing, Housing prices, Inflation, National accounts, Output gap, Potential output, Prices, Production
• Keywords: Bayesian Estimation, core output gap, Financial Frictions, Global, house price, Housing, housing demand shocks, housing price fluctuation, Housing prices, housing stock, Inflation, monetary policy shock, Monetary Union, Output Gap, Potential output, preference shock, WP

Content in this bundle

• _wp15153 - Section 6 studies the monetary policy trade-offs faced by the ECB. Section 7 concludes.
  • _wp15153 - Section 6 studies the monetary policy trade-offs faced by the ECB. Section 7 concludes. (Markdown version)
  • _wp15153 - Section 6 studies the monetary policy trade-offs faced by the ECB. Section 7 concludes. (PDF)