Simulating Banking Sector Dynamics in North Africa: Methodological Insights from DSGE Models

Abstract

North African economies face a structural policy paradox, in which bank-centric financial systems and persistent public-sector dominance complicate coordinating the monetary and fiscal instruments needed for price and debt stability. This study examines how fiscal-monetary interactions shape inflation, output, and debt dynamics in the region, and evaluates which Taylor rule specification best supports stability.We develop a small-scale open-economy DSGE model, extending the Galí and Monacelli (2008) framework with Calvo price rigidities, household heterogeneity, and a monopolistically competitive banking sector subject to capital and liquidity constraints, estimated using Bayesian methods on five macroeconomic observables for North Africa spanning 2000–2022, and compare a standard output-gap Taylor rule (Model 1) with a growth-augmented rule (Model 2).Posterior estimates indicate moderate price rigidity, averaging four quarters, and confirm a monetary dominance regime with active, inflation-responsive rates and substantial interest rate smoothing, while fiscal authorities remain passive and debt-focused. Contractionary monetary shocks generate persistent negative output gaps and crowd out government spending, whereas fiscal shocks produce procyclical, debt-sensitive responses depending on the prevailing monetary rule.The growth-augmented Taylor rule delivers stronger debt stabilization and smoother adjustment, indicating that anchoring policy to output growth improves fiscal-monetary coordination in North Africa.