Capital adjustment costs

Dear all,

i want to compare two models, one with quadratic capital adjustment costs and one without. For the latter i set the parameter for the costs (tau_K) zero.
But doings this yields the following error message, that the rank condition isn’t verified.

There are 7 eigenvalue(s) larger than 1 in modulus
for 8 forward-looking variable(s)

The rank conditions ISN’T verified!

??? Error using ==> print_info
Blanchard Kahn conditions are not satisfied: indeterminacy

Error in ==> stoch_simul at 46
print_info(info, options_.noprint);

Error in ==> NKM at 210
info = stoch_simul(var_list_);

Error in ==> dynare at 132
evalin(‘base’,fname) ;

i checked the model several times, but can’t find any error. It would be great, if you could help me. Thank you
NKM.mod (3.19 KB)

For some parametrizations of real and nominal frictions, capital adjustment costs can be necessary to achieve determinacy: see e.g.
Hence, your model may be completely correct.

Thank you very much! I found that the rank condition is fulfilled, if i write in case of tau_K=0 for k and k(+1) K(-1) and k. But that doesn’t work, if tau_K is unequal zero and so i’m working there with k and k(+1). Can i compare this two models now?

Sorry, but you cannot simply change the timing of the predetermined capital stock. Apparently you are unsure about the correct timing. I guess the timing is the reason the BK conditions are not satisfied. The line

looks as if you ignore the Dynare “stock at the end of a period” timing convention for predetermined states. Please consult page 10 of the manual. If you fix this problem, you will most probably be analyze the question you have at hand.

Thank you very much for your help. I think i understood the timing convention now, unfortunately there is still no solution for my comparision of the two models.

Hi, my question is related to labour adjustment cost. I worked before capital adjustment cost and defined Tobin’s Q for capital. I am wondering If I work with the labour adjustment costs, should I define a Tobin’s Q for labour? The nature of adjustment costs in production function are:



Tobin’s Q is a name for the Lagrange multiplier attached to the law of motion for capital. So if your problem is set up with an additional constraint, then yes, you need something similar. If you just add a cost term, then no.

Thank you. Just to make sure, I added labour adjustment costs as employment protection into the production technology in the formal and informal sector so in that case I believe this is just a cost and no need to lagrange multiplier. Could you please just have a look the production functions?image

If possible, could you please tell me whether I am right or not?


The Lagrange multiplier here would be marginal cost, which is affected by the cost. If you substitute out for output, there will be no multiplier showing up

Thank you. I understand it now. I also have one more question about the law of motion for the capital stock in the formal and informal sector. For the model, I am following Fernandez and Meza (2015) paper. (informal employment and business cycles in emerging market economies) and trying to write their codes. I am really having an issue to understand why households accumulate two different capital stocks, which are specific to formal and informal sectors, and consume formal and informal goods produced in each sector. Formal capital is rented to firms, while informal capital is used in the informal sector. Could you please help me to understand that?model_informality.pdf (120.5 KB)
For me, it makes sense capital goods are produced in the formal sector and informal goods are only consumed but first I am trying to find an intuition for their modelling on capital.

It’s not my model, so I don’t really know. My guess is that for example, if you are producing textiles in the formal sector for exporting, you would not be able to use those machines in the informal sector, because it is a different set of goods that are produced. In a sense, capital is specialized.