Evidence for a Financial Accelerator in a Small Open Economy, and Implications for Monetary Policy

Using Bayesian estimation techniques, we estimatea small open economy dynamic stochastic generalequilibrium model with credit-market imperfectionsfor the Colombian economy. We show thatthe combination of balance sheet effects and thechoice of monetary policy regime are likely to playan important role in the magnification and propagationof initial shocks to the Colombian economy.As an application we show that our model explainsthe 1998-1999 crisis in Colombia, when a sharp risein spreads on a relatively small proportion of internationaldebt were passed strongly onto domesticlending rates, provoking a severe recession.

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