The Role of Financial Frictions in Iran’s Business Cycles: A DSGE Approach

Abstract

B efore the incidence of the financial crisis in 2008, the financial sector was ignored in the most of business cycles analyses. It was assumed that the financial sector played no independent role in describing business cycle fluctuations and followed the real part of the economy. In recent years, modeling financial frictions have been much considered in business cycles literature. The present study aimed to investigate the role of financial friction in Iranian’s business cycles. For this purpose, a dynamic stochastic general equilibrium (DSGE) model is designed based on the structural features of the Iranian economy and is estimated by using Bayesian method and seasonal data during 1370q1- 1395q4 (1991q2-2017q1). The results indicated that the consideration of financial sector in the model increased our understanding of business cycles fluctuations and financial shocks played an influential role in explaining business cycles fluctuations. Further, based on the results of the present study, the persistence of the effect of financial shocks was more compared to the supply and demand sector shocks.