Slide 1

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 2

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 3

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 4

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 5

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 6

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 7

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 8

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 9

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 10

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 11

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 12

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.


Slide 13

A Discussion on “Introducing
Financial Frictions and Unemployment
into a Small Open Economy Model”
(Christiano, Trabandt, and Walentin)
Ichiro Fukunaga
Research and Statistics Department
Bank of Japan
28 October 2009
in Jerusalem

Outline
1. Summary
2. Comments
3. Discussions
(questions and suggestions)

Summary (1):
model overview
• Based on small open economy model of
Adolfson, Laseen, Linde, and Villani.
• Introducing financial frictions
following Bernanke, Gertler, and Gilchrist,
and Christiano, Motto, and Rostagno.
• Introducing labor market search and
matching framework of
Mortensen and Pissarides,
Gertler, Sala, and Triagari, etc.

Summary (2):
baseline small open economy
• Calvo price setting in both export & import.
• Exchange rate shocks take time to pass
into domestic prices.
• Hump-shaped response of output and
exchange rate to a monetary policy shock.
• Uncovered interest rate parity
• Unit-root investment technology shock
• Careful treatment of capital income tax

Summary (3):
financial frictions
• Asymmetric information between
“entrepreneurs” and banks.
• Entrepreneurs have a special skill in
operation and management of capital.
• Capital stock includes both housing and
business capital.
• Interest rate is nominally not statecontingent. >> Fisher effects

Summary (4):
labor market frictions
• Wage setting frictions (Taylor-type)
>> not have a direct impact on on-going
employment relations but on recruiting.
• Labor services are supplied to labor market
by “employment agencies.”
• Wage is determined by Nash bargaining.
• Endogenous separation of employment
from their jobs.
• Symmetry in modeling idiosyncratic shocks

Summary (5):
estimation results
• Bayesian estimation using Swedish data
from 1995Q1 to 2008Q1.
• Among 19 shocks, neutral tech. shock is
important for both output and inflation,
Wealth shock drives 3/4 of investment.
Spillover of financial shocks to unemploymt.
• IRFs of model with unemployment is similar
to those of EHL model.
• Monetary policy shocks are amplified by
financial frictions.

Comments (1):
financial frictions
• Modest effects of financial frictions.
-- Only operation of capital involves frictions.
(Working capital loans are frictionless).
-- Entrepreneurs don’t have assets.
>> In BGG, they have assets and sell output
to Calvo-pricing retailers.
• Too much effects of nominal debt contract?
-- It dampens output/investment responses
to supply shocks.

Comments (1):
financial frictions (cont.)
• External finance premium is not
“risk premium.”
-- just compensation for monitoring cost.
-- Both borrowers and lenders are
risk-neutral under debt contract.
>> Where’s “true” risk premium?
• Data for entrepreneurs’ “net worth.”
-- could be broader than stock market.
-- includes collateral value of illiquid assets.

Comments (2):
labor market frictions
• Similar effects to EHL (sticky wage model).
-- Little effects of unemployment?
-- Passive role of “employment agency.”
• Alternative formulations of bargaining.
-- Which formulation is better?
>> can be decided in terms of
marginal likelihood.
cf. Ichiue, Kurozumi, and Sunakawa
(2008, Bank of Japan WP)

Comments (3):
estimation
• Real variables are log-differenced and
demeaned.
-- consistent with two-sector growth model?
• Measurement errors for most variables.
-- really needed?
-- identification problems (markup shocks)

Discussions (1):
practical uses
• Forecasting performance
-- improved compared with Ramses?
-- better than BVAR?
• Policy simulations
-- monetary policy rule reacting to
credit spread
-- tax policies
-- welfare evaluation among
heterogeneous agents: difficulty?

Discussions (2):
potential output and output gap
• In a simple sticky price/wage model,
estimated potential (=efficient/natural)
output tends to be too volatile.
• In this model with many real frictions,
estimated potential (=efficient) output
may be reasonably smooth.
--- Output gap, in turn, may be volatile
reflecting real frictions.