Introducing financial frictions and unemployment into a small open economy model

Lawrence J. Christiano, Mathias Trabandt, Karl Walentin*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

104 Scopus citations


Which are the main frictions and the driving forces of business cycle dynamics in an open economy? To answer this question we extend the standard new Keynesian model in three dimensions: we incorporate financing frictions for capital, employment frictions for labor and extend the model into a small open economy setting. We estimate the model on Swedish data. Our main results are that (i) a financial shock is pivotal for explaining fluctuations in investment and GDP. (ii) The marginal efficiency of investment shock has negligible importance. (iii) The labor supply shock is unimportant in explaining GDP and no high frequency wage markup shock is needed.

Original languageEnglish (US)
Pages (from-to)1999-2041
Number of pages43
JournalJournal of Economic Dynamics and Control
Issue number12
StatePublished - Dec 2011


  • Bayesian estimation
  • DSGE model
  • Employment frictions
  • Financial frictions
  • Small open economy

ASJC Scopus subject areas

  • Economics and Econometrics
  • Control and Optimization
  • Applied Mathematics

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