Accuracy, Speed and Robustness of Policy Function Iteration

Computational Economics, Vol. 44, Issue 4, 2014

35 Pages Posted: 20 Feb 2013 Last revised: 29 Jun 2015

Alexander W. Richter

Federal Reserve Bank of Dallas

Nathaniel A. Throckmorton

College of William and Mary

Todd B. Walker

Indiana University Bloomington - Department of Economics

Date Written: August 28, 2013

Abstract

Policy function iteration methods for solving and analyzing dynamic, stochastic general equilibrium models are powerful from both a theoretical and computational perspective. Despite obvious theoretical appeal, significant startup costs and a reliance on a grid-based method have limited the use of policy function iteration as a solution algorithm. We reduce these costs by providing a user-friendly suite of MATLAB functions that introduce multi-core processing and Fortran via MATLAB's executable function. We demonstrate why policy function iteration is particularly useful in solving models with regime-dependent parameters, recursive preferences, and binding constraints. We examine a canonical real business cycle model and a new Keynesian model that features regime switching in policy parameters, Epstein-Zin preferences, and monetary policy that occasionally hits the zero-lower bound to highlight the attractiveness of our methodology. We compare our advocated approach to other familiar computational methods, highlighting the tradeoffs between accuracy and speed.

Keywords: Policy Function Iteration, Zero-Lower Bound, Epstein-Zin preferences

JEL Classification: C63, C68, E52, E62

Suggested Citation

Richter, Alexander W. and Throckmorton, Nathaniel A. and Walker, Todd B., Accuracy, Speed and Robustness of Policy Function Iteration (August 28, 2013). Computational Economics, Vol. 44, Issue 4, 2014. Available at SSRN: https://ssrn.com/abstract=2220235 or http://dx.doi.org/10.2139/ssrn.2220235

Alexander W. Richter (Contact Author)

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5360 (Phone)

HOME PAGE: http://alexrichterecon.com

Nathaniel A. Throckmorton

College of William and Mary ( email )

P.O. Box 8795
Williamsburg, VA 23187
United States

HOME PAGE: http://nathrockmorton.people.wm.edu/

Todd B. Walker

Indiana University Bloomington - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

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