EAGLE-FLI: A macroeconomic model of banking and financial interdependence in the euro area

We aim to properly assess domestic and cross-country macroeconomic effects of financial shocks. To do so, we introduce a number of new features in a model previously developed by some of the authors. which together with the full characterization of trade balance and real exchange rate dynamics and with a rich array of financial shocks – allow a detailed analysis of the transmission of financial shocks. We incorporate financial linkages in a multi-country New-Keynesian microfounded general equilibrium model of the euro area by including financial frictions and country-specific banking sectors. The model is non-linear and simulated under perfect foresight. The experiments are run in Dynare. Our results support the views that (1) the business cycles in the euro area can be driven not only by real shocks, but also by financial shocks, (2) the financial sector could amplify the transmission of (real) shocks, and (3) the financial/ banking shocks and the banking sectors can be sources of business cycle asymmetries and spillovers across countries in a monetary union.