How Misleading is Linearization? Evaluating the Dynamics of the Neoclassical Growth Model

46 Pages Posted: 14 Feb 2008 Last revised: 18 Aug 2009

See all articles by Manoj Atolia

Manoj Atolia

Florida State University - Department of Economics

Santanu Chatterjee

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics

Stephen J. Turnovsky

University of Washington - Institute for Economic Research; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: June 30, 2009

Abstract

The standard procedure for analyzing transitional dynamics in non-linear macro models has been to employ linear approximations. This paper investigates the reliability of this procedure in evaluating the dynamic adjustments to policy changes or structural shocks. We analyze this issue using the example of a Ramsey growth model, with two alternative specifications of productive government spending. If government expenditure is introduced as a flow and the dynamic adjustment is fast, linearization may be a reasonably good approximation of the true dynamics even for fairly large policy shocks. If government expenditure assumes the form of a stock, leading to more sluggish adjustment, linearization is more problematic. It may yield misleading predictions, both qualitatively and quantitatively. These errors occur at the beginning of the transition and weigh heavily in welfare calculations. The implications for these errors for temporary shocks and the speed of convergence are also considered.

Keywords: Public expenditure, growth, nonlinearities, welfare analysis

JEL Classification: E62, O41, C63

Suggested Citation

Atolia, Manoj and Chatterjee, Santanu and Turnovsky, Stephen J., How Misleading is Linearization? Evaluating the Dynamics of the Neoclassical Growth Model (June 30, 2009). Available at SSRN: https://ssrn.com/abstract=1092962 or http://dx.doi.org/10.2139/ssrn.1092962

Manoj Atolia

Florida State University - Department of Economics ( email )

Tallahassee, FL 30306-2180
United States
+1.850.644.7088 (Phone)
+1.850.644.4535 (Fax)

HOME PAGE: http://mailer.fsu.edu/~matolia/

Santanu Chatterjee (Contact Author)

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics ( email )

Department of Economics
University of Georgia
Athens, GA 30602
United States
706-542-1709 (Phone)

HOME PAGE: http://https://sites.google.com/view/schatterjee/home

Stephen J. Turnovsky

University of Washington - Institute for Economic Research ( email )

Seattle, WA 98195
United States
206-685-8028 (Phone)
206-543-5955 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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