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Is It Worth Refining Linear Approximations to Non-Linear Rational Expectations Models?

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Author Info
Alfonso Novales () (Univ. Complutense de Madrid)
Javier J. PÈrez () (centrA, and Univ. Pablo de Olavide de Sevilla)

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Abstract

We characterize the balanced growth path of the basic neoclassical growth economy using standard numerical solution methods which solve a linear or log-linear approximation to the economic model, as well as methods which preserve the nonlinearity in the original model. We also apply the same methods adding indivisible labor to the basic model, and to a monetary version of that economy, subject to a cash-in-advance constraint. In a unified framework, we show that log-linear approximations should generally be preferred to linear approximations. We also provide evidence that preserving the original nonlinear structure of the model when computing the numerical solution generally yields minor gains in accuracy. Methods that use either a linear or a log-linear approximation to the model can produce solutions as accurate as the parameterized expectations method. However, in extreme parametric cases, the solution may be rather sensible to small numerical errors, and even a log-linear approximation may then be inappropriate. Methods using the nonlinear structure of the original model can then perform significantly better.

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Publisher Info
Article provided by Springer in its journal Computational Economics.

Volume (Year): 23 (2004)
Issue (Month): 4 (06)
Pages: 343-377
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Handle: RePEc:kap:compec:v:23:y:2004:i:4:p:343-377

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  4. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics 9415, Faculty of Economics, University of Cambridge.
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  6. Alfonso Novales & Emilio Dominguez & Javier J. Perez & Jesus Ruiz, 1998. "Solving Non-linear Rational Expectations Models By Eigenvalue-Eigenvector Decompositions," QM&RBC Codes 124, Quantitative Macroeconomics & Real Business Cycles. [Downloadable!]
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  10. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November. [Downloadable!] (restricted)
  11. Albert Marcet & Guido Lorenzoni, 1998. "The Parameterized Expectations Approach: Some Practical Issues," QM&RBC Codes 128, Quantitative Macroeconomics & Real Business Cycles. [Downloadable!]
  12. Alfonso Novales & Javier J. Pérez, 2002. "Is it Worth Refining Linear Approximations to Non-Linear Rational Expectations Models?," Economic Working Papers at Centro de Estudios Andaluces E2002/15, Centro de Estudios Andaluces. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alfonso Novales & Javier J. PÈrez, 2004. "Is It Worth Refining Linear Approximations to Non-Linear Rational Expectations Models?," Computational Economics, Springer, vol. 23(4), pages 343-377, 06. [Downloadable!]
    Other versions:
  2. Antonio Morales & Pablo Brañas Garza, 2003. "Computational Errors in Guessing Games1," Economic Working Papers at Centro de Estudios Andaluces E2003/11, Centro de Estudios Andaluces. [Downloadable!]
  3. Paul Pichler, 2005. "Evaluating Approximate Equilibria of Dynamic Economic Models," Vienna Economics Papers 0510, University of Vienna, Department of Economics. [Downloadable!]
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