A penalty function approach to occasionally binding credit constraints

Michal Brzoza-Brzezina, Marcin Kolasa and Krzysztof Makarski

No 27, Dynare Working Papers from CEPREMAP

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. 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.

Keywords: financial frictions; DSGE models; occasionally binding constraints; penalty function (search for similar items in EconPapers)
JEL-codes: E30 E44 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2013-06
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (5)

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Related works:
Journal Article: A penalty function approach to occasionally binding credit constraints (2015)
Working Paper: A penalty function approach to occasionally binding credit constraints (2015)
Working Paper: A penalty function approach to occasionally binding credit constraints (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:cpm:dynare:027

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