In the Smets-Wouters DSGE model, the financial friction is introduced by a:
A) "wedge" between consumer interest rates and the federal funds rate.
B) discount rate greater than one.
C) large risk premium.
D) monetary policy parameter ( ) equal to zero.
E) breakdown in the Taylor rule.

Question

In the Smets-Wouters DSGE model, the financial friction is introduced by a:
A) "wedge" between consumer interest rates and the federal funds rate. 
B) discount rate greater than one. 
C) large risk premium. 
D) monetary policy parameter ( ) equal to zero. 
E) breakdown in the Taylor rule.

Quizplus · Accepted Answer

The financial friction in the Smets-Wouters DSGE model is introduced by a "wedge" between consumer interest rates and the federal funds rate. This is a mechanism through which monetary policy affects the economy, and it represents the fact that financial intermediaries charge a spread between their borrowing and lending rates. This spread, or wedge, leads to a distortion in the transmission of monetary policy to households and firms, which affects their consumption and investment decisions.

In the Smets-Wouters DSGE Model, the Financial Friction Is Introduced