Dear dynare forum community,

I set up a model inspired by Smets&Wouters 2007. For the people familiar with their paper some notes on my tweaks:

To simplify that model I got rid of a sticky labor market and of the capital utilization rate. Also, I used a simpler Calvo/Dixit-Stiglitz pricing framework than the more complicated one in SW, resulting in a simpler version of the Philipps-Curve. This model is working and produces reasonable impulse responses. It is also interesting for me to set “investment adjustment costs” to near 0, which I did. Still, the model works and produces reasonable impulse responses.

I want to implement some form ob bounded rationality/myopia into the model inspired by Gabaix (2016) paper about “A behavioral new Keynesian model”.

So the only thing I change in the model in comparison to the framework mentioned above is to implement a Parameter M element [0,1] in the Euler Equation (which is multiplied with the expected consumption C(+1). If this Parameter is set lower than 0.93 the model starts producing a Blanchard Kahn Error:

"

EIGENVALUES:

Modulus Real Imaginary

```
0 0 0
0 0 0
0 0 0
1.908e-15 -1.908e-15 0
0.06141 0.06141 0
0.1327 0.1327 0
0.3397 0.3397 0
0.5 0.5 0
1.005 1.005 0
1.005 1.005 0
1.282 1.282 0
1.286 1.286 0
1.435 1.435 0
2.502 1.823 1.715
2.502 1.823 -1.715
7.183 7.183 0
5.453e+15 -5.453e+15 0
3.265e+16 3.265e+16 0
5.736e+16 5.736e+16 0
Inf Inf 0
Inf Inf 0
```

There are 13 eigenvalue(s) larger than 1 in modulus

for 11 forward-looking variable(s)

The rank condition ISN’T verified!

Error using print_info (line 42)

Blanchard Kahn conditions are not satisfied: no stable equilibrium

Error in stoch_simul (line 100)

print_info(info, options_.noprint, options_);

Error in SW07_mitIAC_mitHabit_flexibleModel (line 273)

info = stoch_simul(var_list_);

Error in dynare (line 235)

evalin(‘base’,fname) ;

model_diagnostics(M_,options_,oo_)

MODEL_DIAGNOSTICS: No obvious problems with this mod-file were detected.

"

I’ve read that BK-Error is usually due to timing errors but then the model should not work without the M Parameter as well. That’s my indication that timing is correct. Also, I did the same experiment with the copy of the code from SW07 without any changes, which produces the same error in that situation.

Right now my deduction is, that this form of bounded rationality is just not working in this model (at least not for the values I want to reach), but I want to find out why. How can I see at what point the model stops working? I already run model_diagnostics which doesn’t indicate any problems. Do you have some ideas on why this error occurs or how I can properly document and understand it?

Link to code on github for error producing model-specification and mod file: https://github.com/Melonenlord/SW07_withIAC_withHabit/blob/master/SW07_withIAC_withHabitSW07_fordynareforum.mod (8.0 KB)