 # Makeup strategies in DSGE model with financial frictions

Dear all,

For my master thesis I would like study how makeup monetary policy strategies perform in terms of financial stability. For this purpose I thought to download a calibrated DSGE model with financial frictions from macromodel base and adding average inflation targeting and price level targeting as monetary policy rules and then running stochastic simulations and see how do these rules perform compared to standard inflation targeting. I must admit that this is the first time I use Dynare, so I am not very confident with the code. In particular I am not very sure how to include average inflation targeting, what would be the best approach to it? How can I modify the standard taylor rule so that the target inflation level is an average?

1. Please see Average inflation targeting
2. If you don’t have experience working with DSGE models, be careful. People are not supposed to work on complicated issues without intense supervision. I have seen too many cases like this miserably fail. Most of the time, the goals set are too unrealistic given the prior training and the time frame envisioned.
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Dear Johannes, Thank you very much for your answer, I will keep that in mind.

What I am trying to do is to incorporate average inflation targeting in Gambacorta and Signoretti (NK_GS14 in mmb) in order to run stochastic simulations and compare them to those under standard inflation targeting. Then I would like to change same parameters linked to the financial system as the level of indebtedness in the economy and see how the outcome changes given different levels of leverage in the economy.

As the model is non linear my current average inflation targeting rule for a 2 years window is the following:

``````1) exp(plev)=exp(plev(-1)+pie);    %price level

2) exp(paitwo)=exp(plev-plev(-8));       %AIT2

3) (1+r_ib) = (1+r_ib(-1))^rho_ib*(1+r_ib_ss)^(1-rho_ib)*(((exp(paitwo)/(piss)))^phi_pie*((exp(Y1))/(exp(steady_state(Y1))))^phi_y)^(1-rho_ib) ;    %TR
``````

Now the problem that I have is that using this approach dynare is not able to find the steady state. If I instead define `exp(paitwo)` as `exp(pie+pie(-1)+pie(-2)+pie(-3)+pie(-4)+pie(-5)+pie(-6)+pie(-7))` which should be equal to `exp(plev-plev(-8))` given equation 1 dynare is actually able to find it but the irfs look pretty weird and oscillating.

Now, I am trying also a different approach where average quarterly inflation over 2 years is defined as exp(paitwo)=exp((pie+pie(-1)+pie(-2)+pie(-3)+pie(-4)+pie(-5)+pie(-6)+pie(-7))/8) actually I obtain much better outcomes.

In the steady state there is no inflation and the initial value for pie is 0.

What do yo think is the source of problems here? Maybe time convention? Some insights would be really appreciated, thank you in advance.

What do you mean with `dynare is not able to find the steady state`? The price level has usually infinitely many possible steady states, implying that you need to provide the one you want to use.

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Dear Johannes,

Thank you for your reply, yes actually there was the specification for the price level missing. Thank you very much.