Hi prof Pfeifer. I’m working on a multi country multi sector NK model. I’m the initial model the discount factor was the same for each country. I want to change it to be country specific. With the change the steady state related to Euler equation for foreign bond no longer holds. How can I specify world interest rate in case of different discount factor for each country for the steady state to solve? Thanks
Often in that type of setup no steady state exists. If one country is much more impatient, it would borrow all it could. Typically, you need some form of closing device, e.g. debt elastic interest rate or an endogenous discount factor.
Thank you for your response. In the current setup there is a risk premium on holding foreign debt. Does a debt elastic interest rate mean the world interest rate would adjust automatically with higher debt from countries with impatient households ? Does that mean the model cannot display a unique world interest rate ? Or the rate would be the same and the risk premium would adjust depending on how patient de agents are ?
If the discount factor is endogenous, with high NFA, would beta rise automatically? Also could you recommend papers in which they have country specific discount factor ? Thanks
Hi Prof Pfeifer, this is a follow up on my question above. Could you please clarify more how to implement the country specific discount factor? Thanks
The relevant interest rate in the Euler equations needs to be conformable with the respective discount factors. Typically, that is a risky interest rate. That type of setup allows for an identical risk-free interest rate across countries. Because discount factors differ, impatient agents will borrow, which increases the risky interest rate they face until the risky interest rate is identical to the rate of time preference.
In any case, you need a mechanism that equilibrates the market for savings.