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A penalty function approach to occasionally binding credit constraints

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Abstract

Occasionally 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. Our simulations 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.

Suggested Citation

  • Michał Brzoza-Brzezina & Marcin Kolasa & Krzysztof Makarski, 2013. "A penalty function approach to occasionally binding credit constraints," NBP Working Papers 159, Narodowy Bank Polski, Economic Research Department.
  • Handle: RePEc:nbp:nbpmis:159
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    Cited by:

    1. Krzysztof Makarski, 2017. "Mnożniki fiskalne w modelu z ograniczeniami kredytowymi," GRAPE Working Papers 13, GRAPE Group for Research in Applied Economics.
    2. Karmakar, Sudipto, 2016. "Macroprudential regulation and macroeconomic activity," Journal of Financial Stability, Elsevier, vol. 25(C), pages 166-178.
    3. Andrew Binning & Junior Maih, 2017. "Modelling Occasionally Binding Constraints Using Regime-Switching," Working Paper 2017/23, Norges Bank.
    4. Laséen, Stefan & Pescatori, Andrea & Turunen, Jarkko, 2017. "Systemic risk: A new trade-off for monetary policy?," Journal of Financial Stability, Elsevier, vol. 32(C), pages 70-85.
    5. Torój, Andrzej, 2017. "Managing external macroeconomic imbalances in the EU: the welfare cost of scoreboard-based constraints," Economic Modelling, Elsevier, vol. 61(C), pages 293-311.

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    Keywords

    financial frictions; DSGE models; occasionally binding constraints; penalty function;

    JEL classification:

    • 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

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