A penalty function approach to occasionally binding credit constraints
AbstractOccasionally binding credit constraints (OBC) have recently been explored as a promising way of modeling financial frictions. However, given their highly non-linear nature, most of the literature has concentrated on small models that can be solved using global methods. In this paper, we investigate the workings of OBC introduced via a smooth penalty function. This allows us to move towards richer models that can be used for policy analysis. We show that in a deterministic setting the OBC approach delivers welcome features, like asymmetry and non-linearity in reaction to shocks. However, feasible local approximations, necessary to generate stochastic simulations, suffer from fatal shortcomings that make their practical application questionable.
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Bibliographic InfoPaper provided by CEPREMAP in its series Dynare Working Papers with number 27.
Length: 36 pages
Date of creation: Jun 2013
Date of revision:
financial frictions; DSGE models; occasionally binding constraints; penalty function;
Other versions of this item:
- Michał Brzoza-Brzezina & Marcin Kolasa & Krzysztof Makarski, 2013. "A penalty function approach to occasionally binding credit constraints," National Bank of Poland Working Papers, National Bank of Poland, Economic Institute 159, National Bank of Poland, Economic Institute.
- E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-06-24 (All new papers)
- NEP-DGE-2013-06-24 (Dynamic General Equilibrium)
- NEP-MAC-2013-06-24 (Macroeconomics)
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- Gerlach, Petra & Merola, Rossana, 2013. "Consumption and Credit Constraints: A Model and Evidence for Ireland," Papers, Economic and Social Research Institute (ESRI) WP471, Economic and Social Research Institute (ESRI).
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