Abstract
We develop a small open production economy model in which external debt, corporate domestic debt, and risky equities coexist. Our economy features shocks to short- and long-run productivity, as well as shocks to both domestic credit conditions and global credit markets. We show that credit shocks are an important determinant of economic fluctuations in a model consistent with asset pricing facts. According to a novel empirical investigation from many small-but-developed countries, our setting features a powerful quantitative performance well-suited for future monetary and fiscal policy analysis.
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