Fleshing out the Monetary Transmission Mechanism: Output Composition and the Role of Financial Frictions

Financial frictions affect the way in which different macroeconomic series respond to a monetary policy shock. We embed the financial accelerator of Bernanke, Gertler, and Gilchrist (1999) into a medium-scale DSGE model and evaluate the relative importance of financial frictions in explaining monetary transmission. Specifically, we apply minimum distance estimation based on impulse responses for the Volcker-Greenspan period. Apart from providing estimates for structural parameters, our procedure lends itself for specification tests that can be used to assess the relative fit of various restricted models. Financial frictions turn out to be of lesser importance for the descriptive success of our model.