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How misleading is linearization? Evaluating the dynamics of the neoclassical growth model

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  • Atolia, Manoj
  • Chatterjee, Santanu
  • Turnovsky, Stephen J.

Abstract

This paper investigates the reliability of employing linearization to evaluate the dynamic adjustments to changes in productive government spending in a Ramsey growth model. If government expenditure is introduced as a flow and the dynamic adjustment is fast, linearization may yield a reasonably good approximation to the true dynamics, even for fairly large policy shocks. If government expenditure assumes the form of a stock, leading to more sluggish adjustment, linearization may yield misleading predictions. These errors occur at the beginning of the transition and weigh heavily in welfare calculations. The implications for temporary shocks and the speed of convergence are also considered.

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  • Atolia, Manoj & Chatterjee, Santanu & Turnovsky, Stephen J., 2010. "How misleading is linearization? Evaluating the dynamics of the neoclassical growth model," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1550-1571, September.
  • Handle: RePEc:eee:dyncon:v:34:y:2010:i:9:p:1550-1571
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    Cited by:

    1. Mário Amorim Lopes & Fernando A. C. C. Fontes & Dalila A. C. C. Fontes, 2013. "Optimal Control of Infinite-Horizon Growth Models — A direct approach," FEP Working Papers 506, Universidade do Porto, Faculdade de Economia do Porto.
    2. Dieppe, Alistair & González Pandiella, Alberto & Willman, Alpo, 2012. "The ECB's New Multi-Country Model for the euro area: NMCM — Simulated with rational expectations," Economic Modelling, Elsevier, vol. 29(6), pages 2597-2614.
    3. Manoj Atolia, 2010. "Public Investment, Tax Evasion, And The Welfare Effects Of A Tariff Reform," Contemporary Economic Policy, Western Economic Association International, vol. 28(2), pages 219-239, April.
    4. Agénor, Pierre-Richard & Canuto, Otaviano & da Silva, Luiz Pereira, 2014. "On gender and growth: The role of intergenerational health externalities and women's occupational constraints," Structural Change and Economic Dynamics, Elsevier, vol. 30(C), pages 132-147.
    5. Atolia, Manoj & Chatterjee, Santanu & Turnovsky, Stephen J., 2012. "Growth and inequality: Dependence on the time path of productivity increases (and other structural changes)," Journal of Economic Dynamics and Control, Elsevier, vol. 36(3), pages 331-348.
    6. Turnovsky, Stephen J., 2011. "On the role of small models in macrodynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 35(9), pages 1605-1613, September.
    7. Jonathan Temple & Huikang Ying & Patrick Carter, 2014. "Transfers and Transformations: Remittances, Foreign Aid, and Growth," Bristol Economics Discussion Papers 14/649, Department of Economics, University of Bristol, UK, revised 02 Dec 2014.
    8. Kirkby, Robert, 2017. "Transition paths for Bewley-Huggett-Aiyagari models: Comparison of some solution algorithms," Working Paper Series 5642, Victoria University of Wellington, School of Economics and Finance.
    9. Mahbub Morshed, A.K.M. & Turnovsky, Stephen J., 2011. "Real exchange rate dynamics: The role of elastic labor supply," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1303-1322.
    10. OA Carboni & G. Medda, 2010. "A Neoclassical Growth Model with Public Spending," Working Paper CRENoS 201033, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
    11. Groneck, Max, 2010. "A golden rule of public finance or a fixed deficit regime?: Growth and welfare effects of budget rules," Economic Modelling, Elsevier, vol. 27(2), pages 523-534, March.
    12. Groneck, Max, 2008. "A Golden Rule of Public Finance or a Fixed Deficit Regime? Growth and Welfare Effects of Budget Rules," FiFo Discussion Papers - Finanzwissenschaftliche Diskussionsbeiträge 08-7, University of Cologne, FiFo Institute for Public Economics.
    13. Pedro Mazeda Gil & Oscar Afonso & Paulo B. Vasconcelos, 2015. "Skill-Structure Shocks, the Share of the High-Tech Sector and Economic Growth Dynamics," FEP Working Papers 554, Universidade do Porto, Faculdade de Economia do Porto.
    14. Klarl, Torben, 2016. "Pollution externalities, endogenous health and the speed of convergence in an endogenous growth model," Journal of Macroeconomics, Elsevier, vol. 50(C), pages 98-113.
    15. Giulia FELICE, 2009. "Size and composition of public investment, structural change and growth," Departmental Working Papers 2009-28, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano, revised 27 Dec 2011.
    16. Junying Zhao & William Scarth & Jeremiah Hurley, 2015. "Investing in Health: A Macroeconomic Exploration of Short-Run and Long-Run Trade-Offs," Department of Economics Working Papers 2015-15, McMaster University.
    17. Pedro Mazeda Gil & Oscar Afonso & Paulo B. Vasconcelos, 2013. "Industry Dynamics and Aggregate Stability over Transition," FEP Working Papers 484, Universidade do Porto, Faculdade de Economia do Porto.

    More about this item

    Keywords

    Public expenditure Growth Nonlinearities Welfare analysis;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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