Rationale behind adjustment costs in DSGE models

General DSGE Modeling
1

Dear all,

This is most probably a very trivial question, but I’ve always wondered about it. I totally understand the economic reasoning why one would introduce capital adjustment costs. However, nowadays most DSGE models have a variety of adj. costs implemented in their frameworks (e.g. adj. costs on loans, deposits, housing, etc.). What is the rationale in these cases? Is just to make the transformation/accumulation process costly in order that the model fits the data better, due to slow movement of macro variables?

Thanks for helping me out with this. I had a look at the forum and the literature but couldn’t find any good explanations.

Best

Robert

2

Yes, usually that is the case. The IRFs from structural VARs are usually hump-shaped with quite a lot of persistence. Our basic models do usually not produce much internal propagation. The solution the majority of the literature adopts is to add adjustment costs, habits, etc.

3

Thanks a lot Johannes, that explains it.