Instability Problem in Open Economy with Endog. Borr Limit

[kay]

Dear all,

I have a simple open economy RBC model with an endogenous borrowing limit, debt can only be a fraction kappa of the capital stock Q_t*K_{t+1}.

I am pretty sure that my timing is correct in the equations. The problem is that the model is unstable if I use standard values for the capital adjustment cost a. I can only use very low values such as 0.25 or 0.5, and at 0.5 the IRFs already start “shaking”… I can easily solve the unconstrained case with capital adjustment cost values of a=3, but not the model with the borrowing constraint.

Has anybody an idea why that is happening or has anyone seen similar problems/issues and knows a good reference?

Best regards and thanks a lot for any suggestions
Kay

[valerio88]

Hi Kay my model is very close to yours (without adj costs and with the borrowing constraint as a function of past capital). My model works if I do not have foreign goods, while BK conditions are not met once I add foreign goods, giving a role to the exchange rate. Here the link to my post
viewtopic.php?f=1&t=10102

I had a look at your code and I have a couple suggestions:
-You forgot chi in the definition of marginal utility
-The steady state of labor is really low, usually it should be around 1/3 of output.

I do not know if this solves the problem, I hope it can help you.
Good luck!
Valerio

[kay]

Thanks a lot, valerio. I think I found a way, I just reduce the amount of debt via reducing kappa.

Thanks a lot
Best
Kay