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How well do linear approximation methods work? results for suboptimal dynamic equilibria

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  • Michael Dotsey
  • Ching-Sheng Mao

Abstract

Real business cycle models have recently been applied to settings in which equilibria are suboptimal. In most models the solutions are approximated using some type of linearization with little attention being given to the accuracy of the approximation. In this paper we investigate three different approximation methods in the context of a neoclassical model with a production tax and compare their solutions with solutions obtained from a discrete state space solution to the Euler equations of the model.

Suggested Citation

  • Michael Dotsey & Ching-Sheng Mao, 1990. "How well do linear approximation methods work? results for suboptimal dynamic equilibria," Working Paper 90-11, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:90-11
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    References listed on IDEAS

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    1. Auerbach, Alan J & Hines, James R, Jr, 1988. "Investment Tax Incentives and Frequent Tax Reforms," American Economic Review, American Economic Association, vol. 78(2), pages 211-216, May.
    2. Baxter, Marianne & Crucini, Mario J & Rouwenhorst, K Geert, 1990. "Solving the Stochastic Growth Model by a Discrete-State-Space, Euler-Equation Approach," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 19-21, January.
    3. Baxter, Marianne, 1991. "Approximating suboptimal dynamic equilibria : An Euler equation approach," Journal of Monetary Economics, Elsevier, vol. 28(2), pages 173-200, October.
    4. Brock, William A. & Mirman, Leonard J., 1972. "Optimal economic growth and uncertainty: The discounted case," Journal of Economic Theory, Elsevier, vol. 4(3), pages 479-513, June.
    5. Wouter J. Den Haan & Albert Marcet, 1994. "Accuracy in Simulations," Review of Economic Studies, Oxford University Press, vol. 61(1), pages 3-17.
    6. King, R.G. & Baxter, M., 1990. "Productive Externalities And Cyclical Volatility," RCER Working Papers 245, University of Rochester - Center for Economic Research (RCER).
    7. Dotsey, Michael, 1990. "The Economic Effects of Production Taxes in a Stochastic Growth Model," American Economic Review, American Economic Association, vol. 80(5), pages 1168-1182, December.
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    Keywords

    Business cycles;

    Statistics

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