BKK endowment economy

Stochastic simulations
1

Hello everyone,

I am running a simple exercise based on BKK’s 2 country model. Suppose that there is a world with 2 countries as in BKK but there is no production, it is an endowment economy. I am attaching a pdf with the model and dynare code.

I have some questions:

  1. Does it have sense to think in this seeting about cross correlation between consumption and output (“quantity puzzle”) ?

  2. If I introduce the same structure of shocks as in BKK I don’t have problems in running the code. However, I have problems if I specify a negative correlation between shocks. Actually I get this error:

" The specified covariances for the structural errors are not consistent with the variances as they imply a correlation larger than ±1"

Thank you,
Emilio

Endowment_BKK.pdf (108.5 KB) endowment_nolin.mod (705 Bytes)

2
  1. Why shouldn’t it make sense? You are missing the endogenous production, but think about the endowment as a short-cut. The puzzle is still about the movement of consumption.
  2. You did not specify a negative correlation. You set
corr eps_zh, eps_zh

which is a correlation of a shock with itself.

3

Thank for your answer Johannes.

  1. Yes, the puzzle is still there. Now consumption correlation is equal to 1 (since ch = cf = 0.5*Y), this is true by definition. On the other hand, I can play with the correlation between yh and yf by changing spillovers effects and correlation of shocks. These are the correlations that I get:

CORRELATION OF SIMULATED VARIABLES (HP filter, lambda = 1600)
VARIABLE ch cf yh yf y
ch 1.0000 1.0000 0.4514 0.8573 1.0000
cf 1.0000 1.0000 0.4514 0.8573 1.0000
yh 0.4514 0.4514 1.0000 -0.0724 0.4514
yf 0.8573 0.8573 -0.0724 1.0000 0.8573
y 1.0000 1.0000 0.4514 0.8573 1.0000

  1. Yes, you are totally right. I don’t know how I could not see this error. Thank you for clarifying this.

Emilio