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Two Pitfalls of Linearization Methods

  • JINILL KIM
  • SUNGHYUN HENRY KIM

This paper illustrates two types of pitfalls when linearization methods are improperly applied. First, if we linearize the constraints before deriving the optimality conditions, the derived conditions are not correct up to first order. Second, even when we obtain the behavior of the economy that is correct to the first order, applying this behavior to welfare implications may lead to incorrect results. We also review different ways to avoid those pitfalls. Copyright 2007 The Ohio State University.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1538-4616.2007.00055.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 39 (2007)
Issue (Month): 4 (06)
Pages: 995-1001

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Handle: RePEc:mcb:jmoncb:v:39:y:2007:i:4:p:995-1001
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," NBER Working Papers 10838, National Bureau of Economic Research, Inc.
  2. Jinill Kim & Sunghyun Henry Kim, 1999. "Spurious Welfare Reversals in International Business Cycle Models," Virginia Economics Online Papers 319, University of Virginia, Department of Economics.
  3. Pierpaolo Benigno & Michael Woodford, 2008. "Linear-Quadratic Approximation of Optimal Policy Problems," Discussion Papers 0809-01, Columbia University, Department of Economics.
  4. Pierpaolo Benigno & Michael Woodford, 2004. "Optimal taxation in an RBC model: A linear-quadratic approach," Discussion Papers 0405-16, Columbia University, Department of Economics.
  5. Jinill Kim & Dale Henderson, 2002. "Inflation Targeting and Nominal Income Growth Targeting: When and Why Are They Suboptimal?," Computing in Economics and Finance 2002 59, Society for Computational Economics.
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