Assessing macro-financial linkages: A model comparison exercise

The recent global financial crisis has increased interest in macroeconomic models that incorporate financial frictions. We illustrate the simulation properties of five medium-sized general equilibrium models used by central banks in the Eurosystem. The models include a financial accelerator mechanism (convex “spread” costs related to firms' leverage) and/or collateral constraints (based on asset values). We provide results from impulse responses to shocks originating in the financial sector as well as a monetary policy shock. Overall, the models share qualitatively similar and interpretable features. This gives us confidence that we have some common understanding of the mechanisms involved. Finally, we survey recent trends in the literature on financial frictions.

► The financial crisis renewed interest on financial markets and the real economy. ► We compare five medium-sized DSGE models that incorporate financial linkages. ► Aspects considered are the financial accelerator and collateral constraints. ► We discuss limits of existing models and future research directions.