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Modelling Occasionally Binding Constraints Using Regime-Switching

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  • Andrew Binning

    ()

  • Junior Maih

    ()

Abstract

Occasionally binding constraints are part of the economic landscape: for instance recent experience with the global financial crisis has highlighted the gravity of the lower bound constraint on interest rates; mortgagors are subject to more stringent borrowing conditions when credit growth has been excessive or there is a downturn in the economy. In this paper we take four common examples of occasionally binding constraints in economics and demonstrate how to use regime-switching to incorporate them into DSGE models. In particular we investigate the zero lower bound constraint on interest rates, occasionally binding collateral constraints, downward nominal wage rigidities and irreversible investment. We compare our approach against some well-known methods for solving occasionally-binding constraints. We demonstrate the versatility of our regime-switching approach by combining multiple occasionally binding constraints to a model solved using higher-order perturbation methods, a feat that is difficult to achieve using alternative methodologies.

Suggested Citation

  • Andrew Binning & Junior Maih, 2017. "Modelling Occasionally Binding Constraints Using Regime-Switching," Working Papers No 9/2017, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
  • Handle: RePEc:bny:wpaper:0058
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    Cited by:

    1. Lansing, Kevin J., 2017. "Endogenous Regime Switching Near the Zero Lower Bound," Working Paper Series 2017-24, Federal Reserve Bank of San Francisco.

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    Keywords

    Occasionally Binding Constraints; DSGE models; ZLB; Collateral Constraints;

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