Financial factors had been mostly neglected in the mainstream macro literature in the last twenty years before the 2007-2009 global financial crisis. The latest financial turmoil served as a wake-up call, which made it clear that business cycle modelling can no longer ignore the financial sector. Economists have been working to revive this tradition by incorporating financial frictions into standard business cycle models. However, the literature has been silent about how financial frictions work in the general equilibrium framework of two asymmetric countries.

In this seminar, Xuan-Lam develops a business cycle model of two asymmetric countries in which independent banking sectors are subject to moral hazards due to their ability to divert assets. The model allows for an incentive compatibility constraint on a diverse portfolio of loans as well as financial frictions on cross-border lending and the presence of exogenous entrepreneurial net worth. Using a Bayesian likelihood approach, he estimates the model with Australian and U.S. macro finance data. He finds that: (i) the presence of financial frictions improves the fit of the model; (ii) the model with a full incentive compatibility constraint outperforms its less constrained variants and the pure trade open economy model in reproducing the cross-border synchronisation of business cycles; and (iii) domestic financial shocks account for a substantial portion of business cycle fluctuations within the country and foreign financial shocks play a non-negligible role in cross-border spillovers.

Xuan-Lam Nguyen is a PhD candidate in economics at the Crawford School of Public Policy. His dissertation focuses on development of cross-country New Keynesian DSGE models with financial frictions. He builds up a frictionless international business cycle model of two asymmetric countries and then incorporates the existing financial friction approaches with the dual aim of advancing the understanding of the role of financial factors and providing new insights into the two asymmetric country setting. Xuan-Lam was a university lecturer in economics in Vietnam before commencing his PhD at the ANU.

The CAMA Macroeconomics Brown Bag Seminars offer CAMA speakers, in particular PhD students, an opportunity to present their work in progress in front of their peers, and reputable visitors to showcase their work.