Error // Central bank's policy rule as a combination of two AR processes

Stochastic simulations
1

Dear all,

I’m trying to replicate some impulse responses to a credit shock (theta). The problem in my simulation is the interest rate rule which the central bank follows: r_s = r_star + nu*theta, where r_star is the natural rate and nu is a parameter, which is a combination of several other parameters of the model (please see attached). r_star as well as theta follow exogenous AR(1) processes.

When I try to run the code, I get the following error message:

There are 2 eigenvalue(s) larger than 1 in modulus
for 3 forward-looking variable(s)

I think it’s because the 5th equation (the policy rule) is a combination of two other equations in the model which leads to indeterminancy (am I right?)

Could you please help me with this issue? I’m not experienced in dynare yet and would be glad to receive a hint how to adjust the model to make the code work.

Thanks a lot.probe3.mod (1.4 KB)

2

Usually, an exogenous interest rate peg violates the Taylor principle. That may be the reason.

3

Hmm but the authors of the paper that I’m trying to replicate use this interest rate rule and create some impulse responses… Then it should be possible. (they set the interest rate according to fluctuations of the natural interest rate and the credit shock)
Could you please explain how it might be possible?
Thanks a lot.

4

Without the paper it is impossible to tell what is going on.