Financial intermediaries in an estimated DSGE model for the United Kingdom

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 19 March 2012

Working Paper No. 431
By Stefania Villa and Jing Yang

Gertler and Karadi combined financial intermediation and credit policy in a DSGE framework. We estimate their model with UK data using Bayesian techniques. To validate the fit, we evaluate the model’s empirical properties. Then we analyse the transmission mechanism of the shocks, set to produce a downturn. Finally, we examine the empirical importance of nominal, real and financial frictions and of different shocks. We find that banking friction seems to play an important role in explaining the UK business cycle. Moreover, the banking sector shock seems to explain about half of the fall in real GDP in the recent crisis. A credit supply shock seems to account for most of the weakness in bank lending.

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