ABSTRACT

This chapter constructs a dynamic general equilibrium, sticky-price model of a small open economy to study the impact of international financial integration on business cycle volatility. Though the integration of financial markets may affect business cycle stability in many ways, this chapter will focus on the financial accelerator channel (Bernanke 2007). In the financial accelerator framework, the health of the balance sheets of corporate firms and financial intermediaries is an important determinant of investment expenditure. In line with Carlstrom and Fuerst (1997) and Bernanke, Gertler, and Gilchrist (1999), financial accelerator mechanisms have been incorporated into dynamic stochastic general equilibrium models to study the business cycle characteristics of investment.1