A Comparative Estimation of Financial Frictions in Japan and Korea

We apply the Business Cycle Accounting method a la Chari, Kehoe, and McGrattan (2007) to the Japanese and the Korean economy and quantitatively analyze the effects of financial frictions during the recent recessions. First, we compute exogenous distor- tions in the financial, government purchases, labor, and production markets. The preliminary results show that the sudden drop in production efficiency (TFP) was the main reason of the Korean recession while the increase in labor market distortions was the main reason of the Japanese slump. Next, we orthogonalize the innovations to the distortions and quantify the maximum spill-over effects of financial frictions on output fluctuations in both countries following Christiano and Davis (2006). Our results imply that financial frictions may have been important in explaining the recessions in both countries through their effects on TFP and labor market distortions.