Financial frictions in a macroeconometric model: A counterfactual analysis for the case of Slovenia

Abstract

The paper investigates the importance of modelling the effects of financial frictions in a macroeconometric framework for the small open economy of Slovenia. We enhance the model with additional behavioural equations pertaining to business and residential investment, the respective lending rates, and the gross operating surplus of non-financial companies. The estimation period spans from 1999Q1 to 2019Q4, meaning a period of significant financial distress was included in the analysis. Counterfactual analysis was conducted by comparing simulation results from a macroeconometric model with the explicit modelling of financial frictions to a model with limited transmission effects. The results indicate that financial frictions significantly hinder macroeconomic development under adverse macroeconomic scenarios. Policymakers’ measures should focus on maintaining financial sector stability and enabling external financing access for non-financial companies and households during adverse economic situations.