Modelling Occasionally Binding Constraints Using Regime-Switching

92 Pages Posted: 20 Nov 2017

Date Written: November 14, 2017

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.

Keywords: Occasionally Binding Constraints; DSGE Models; ZLB; Collateral Constraints

Suggested Citation

Binning, Andrew and Maih, Junior, Modelling Occasionally Binding Constraints Using Regime-Switching (November 14, 2017). Norges Bank Working Paper 23/2017, Available at SSRN: https://ssrn.com/abstract=3073753 or http://dx.doi.org/10.2139/ssrn.3073753

Andrew Binning (Contact Author)

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

Junior Maih

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

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