An Estimated Small Open Economy Model of the Financial Accelerator

This paper develops a small open economy model where entrepreneurs partially finance investment using foreign currency denominated debt subject to a risk premium above and beyond international interest rates. We use Bayesian estimation techniques to evaluate the importance of balance sheet vulnerabilities combined with the presence of the financial accelerator for emerging market countries. Using Korean data, we obtain an estimate for the external risk premium, indicating the importance of the financial accelerator and potential balance sheet vulnerabilities for macroeconomic fluctuations. Furthermore, our estimates of the Taylor rule imply a strong preference to smooth both exchange rate and interest rate fluctuations.Financial sector;Exchange rates;Savings;Economic models;exchange rate, standard deviation, probability, equation, calibration, exchange rate fluctuations, real exchange rate, time series, exchange rate regime, probabilities, exchange rate policy, exchange rate depreciation, nominal exchange rate, random walk, correlation, equations, fixed exchange rate, markov chain, stochastic processes, statistic, sampling, standard deviations, computation, fixed exchange rate regime, alternative exchange rate, exchange rate flexibility, linear time, flexible exchange rate, general equilibrium model, nonlinear model, linear time trend, cumulative distribution function, exchange rate movements, dollar exchange rate, survey, general equilibrium models, covariance, gamma distributions, data analysis, estimation procedure, econometrics, real exchange rates, real exchange rate depreciation, functional form, exchange rate pass, fixed exchange rates, flexible exchange rate regime, calibrations, probability models, bayesian analysis