Financial Frictions in a Small Open Economy: The Case of Czech Republic

In the period during the Great Recession, it has been clear that financial factors played important role in economic downturn. Hence, abstracting from them in the business cycle modelling is currently no longer a valid simplification. In the submitted paper, we interpret structure and behaviour of a bayesian small open economy DSGE model with financial frictions. Originally, this is a Swedish New Keynesian model estimated and analysed on Czech data. Czech economy has been currently overheating and is subject to turbulent development in terms of key macroeconomic variables. The aim is to contribute in understanding financial frictions in the Czech economy and their impact on business cycle. We provide results of the economy in the period of recession and overheating using impulse responses framework and shock decomposition techniques. Where possible, financial frictions specification is compared to a baseline (frictionless) model.