Instability Problem in Open Economy with Endog. Borr Limit

[kay]

Dear all,

I have a simple open economy RBC model with an endogenous borrowing limit, debt can only be a fraction kappa of the capital stock Q_t*K_{t+1}.

I am pretty sure that my timing is correct in the equations. The problem is that the model is unstable if I use standard values for the capital adjustment cost a. I can only use very low values such as 0.25 or 0.5, and at 0.5 the IRFs already start “shaking”… I can easily solve the unconstrained case with capital adjustment cost values of a=3, but not the model with the borrowing constraint.

Has anybody an idea why that is happening or has anyone seen similar problems/issues and knows a good reference?

Best regards and thanks a lot for any suggestions
Kay

[valerio88]

Hi Kay my model is very close to yours (without adj costs and with the borrowing constraint as a function of past capital). My model works if I do not have foreign goods, while BK conditions are not met once I add foreign goods, giving a role to the exchange rate. Here the link to my post

SOE and Collateral Constraint

Hi everybody, I am building a DSGE for a small open economy (SOE) that borrows abroad, subject to a collateral constraint. If in the economy there is just one international good (so that debt is denominated in this good which is the same good produced by the SOE and the exchange rate is 1) the model works fine. Since I would like to give a role to the exchange rate, I have slightly changed the model by including a foreign good as an input in the production function; moreover, I assume that fore…

I had a look at your code and I have a couple suggestions:
-You forgot chi in the definition of marginal utility
-The steady state of labor is really low, usually it should be around 1/3 of output.

I do not know if this solves the problem, I hope it can help you.
Good luck!
Valerio

[kay]

Thanks a lot, valerio. I think I found a way, I just reduce the amount of debt via reducing kappa.

Thanks a lot
Best
Kay