Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function

25 Pages Posted: 3 Aug 2001

See all articles by Stephanie Schmitt-Grohé

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: January 31, 2002

Abstract

This paper derives a second-order approximation to the solution of a general class of discrete-time rational expectations models. The main theoretical contribution of the paper is to show that for any model belonging to the general class considered, the coefficients on the terms linear and quadratic in the state vector in a second-order expansion of the decision rule are independent of the volatility of the exogenous shocks. In other words, these coefficients must be the same in the stochastic and the deterministic versions of the model. Thus, up to second order, the presence of uncertainty affects only the constant term of the decision rules. In addition, the paper presents a set of MATLAB programs designed to compute the coefficients of the second-order approximation. The validity and applicability of the proposed method is illustrated by solving the dynamics of a number of model economies.

Keywords: dynamic general equilibrium models, perturbation methods, second-order approximation

JEL Classification: E0, C63

Suggested Citation

Schmitt-Grohe, Stephanie and Uribe, Martin, Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function (January 31, 2002). Available at SSRN: https://ssrn.com/abstract=277709 or http://dx.doi.org/10.2139/ssrn.277709

Stephanie Schmitt-Grohe

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

National Bureau of Economic Research (NBER)

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Martin Uribe (Contact Author)

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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