Financial frictions and monetary policy shocks in Sierra Leone: dynamic stochastic general equilibrium model

Abstract

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 characteristics with financial frictions acquainted with activities of heterogeneous agents in the households drawing. Using the Bayesian technique, the study employed quarterly macroeconomic data in Sierra Leone from 2007Q1 to 2021Q4. The findings from this study shows that financial friction shocks have transient converging effect on inflation and a negative impact on output gap in Sierra Leone. The monetary policy shock also 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 in Sierra Leone. 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 stabilising prices with monetary policy geared at productivity at levels that are growth inducing and not inimical to stabilising inflation.