Gali Monacelli ('05) with foreign interest rate shock

Stochastic simulations
1

Hi everyone,

I am trying to implement a foreign interest rate shock in a 2-country version of the Gali Monacelli ('05) SOE paper, adapting the code made available by Johannes Pfeifer . However, when I run the simulation I get the following error:

Error using print_info (line 37)
The generalized Schur (QZ) decomposition failed. For more information, see the documentation for Lapack function dgges:
info=11, n=9. You can also run model_diagnostics to get more information on what may cause this problem.

I suspect it might be because I express the interest parity condition as backward-looking, but if I express it as forward-looking the Blanchard-Kahn conditions are satisfied.

Thanks in advance for any help.

SOE2country.mod (6.0 KB)

2

Running model_diagnostics returns a collinearity issue related to the parity condition. Depending on your market structure, the UIP only holds in expectations, because the exchange rate change is not known in advance.

3

Dear professor Pfeifer,

Thanks for the help. Yes in the model the UIP only holds in expectations and I suspected that might be the cause of the problem. However, after writing it in expectations I get the same error. Any idea as to why it might still be the case? You can find the relevant .mod file attached.

SOE2country.mod (5.9 KB)

4

You sill have a collinearity issue. You need to find out why.