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Modelling Occasionally Binding Constraints Using Regime-Switching

Andrew Binning and Junior Maih ()

No No 9/2017, Working Papers from Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School

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 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge
Date: 2017-12
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