Financial accelerator mechanism in a small open economy: DSGE model of the Czech economy

Our research is motivated by current experience of worldwide economic difficulties that suggests that it could be the banking sector that can to a certain extent cause and exacerbate economic recessions. In this paper we focus on the effects of financial accelerator mechanism in the Czech economy in recent period of unstable financial sector and the debt crisis in the EU. In order to be able to assess the importance of the financial frictions in this particular economy, a DSGE model of a small open economy is estimated. Model framework containing financial accelerator mechanism proposed by Bernanke, Gertler and Gilchrist (1999) is used for the analysis. The original model specification is slightly altered by adding a shock in entrepreneurial net-worth. Also, we decided to model the foreign sector as a VAR block, which enables us to impose more structure on foreign variables than independent AR processes. Quarterly data from period 1999 to 2011 are used for the estimation. Model parameters are estimated with the use of Bayesian techniques. A method of shock decomposition is used to analyze historical development of endogenous variables and to evaluate particular effects of individual exogenous shocks.