Hello everyone,
I have set up a simple New Keynesian model (mod file attached) where the policy maker’s loss contains interest rate volatility (weight = \lambda_{R}). I have solved the model by
- using discretionary_policy
and - combining the first order conditions and running stoch_simul
For low values of \lambda_{R} the results are identical, as one would expect. However, as soon as this weight begins to rise (e.g., to 0.5) I obtain indeterminacy when solving stoch_simul but not when using discretionary_policy.
Moreover, I’ve tested it using Klein’s solab.m and it also results in indeterminacy.
Given that we have an analytical expression for policy under this simple model the two solution methods should yield identical results. Is this a bug in discretionary_policy?
Thank you.
NK_omp_R_volatility_forum.mod (1.0 KB)