A financial accelerator in the business sector of a macro-econometric model of a small open economy

Abstract

We have incorporated afinancial accelerator mechanism operating through investments in thebusiness sector in a dynamic macroeconometric model of the Norwegian economy. In this newand amended model aggregated credit and equity prices are determined simultaneously in asystem characterized by a two-directional contemporaneous causal link, which has been designedand estimated by a new procedure for simultaneous structural model design. Combined with amechanism where credit and asset prices are mutually influenced by real investments, this cre-ates afinancial accelerator amplified by a credit-asset price spiral. Simulations illustrate how theintroduction of afinancial accelerator significantly reinforces and extends the economic cycles inprojections and forecasts, in particular when confronted by a severe shock. Furthermore,monetary policy has a markedly stronger effect in the short and medium term, while the impactoffiscal policy is affected to a relatively small degree as it is more remotely linked tofinancialmarkets.