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Financial Frictions and Monetary Policy Shocks in a Small Open Economy DGSE Model: Evidence from Sierra Leone

Leroy N. Johnson


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The paper investigates the role of financial frictions and monetary policy in Sierra Leone within the Bayesian Dynamic Stochastic General Equilibrium (DSGE) framework. This Bayesian DSGE model mirrors a small open economy characteristic with financial frictions acquainted with activities of heterogeneous agents in the households drawing. Using the Bayesian technique, the study employed quarterly macroeconomic data from 2007q1 to 2021q4. The findings from this study shows that financial friction shocks has transient converging effect on inflation and a negative impact on output gap. The monetary policy shock has a negative but assuaging impact on output gap, demand shock has a transient negative impact on output growth while the productivity (supply) shock has a positive impact on output growth. The economics of the monetary policy shocks is that it assuages the contractionary impact on the economy albeit monetary policy alone cannot steer the economy to stimulate growth dynamics. Concerning the financial shocks, the economic intuition is that it is inimical to trust in the banking sector. These findings are evident that monetary authorities should boost financial system stability, thereby increasing confidence in the banking sector and revamp their efforts in stabilizing prices with monetary policy geared at productivity at levels that are growth inducing and not inimical to stabilizing inflation.

JEL Codes: C59, E32, E52, F41

Keywords: Monetary policy, financial frictions, small-open economy, dynamic stochastic general equilibrium modelling, Bayesian estimation.






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