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

Manoj Atolia (), Santanu Chatterjee () and Stephen J Turnovsky

No wp2008_11_01, Working Papers from Department of Economics, Florida State University

Abstract: The standard procedure for analyzing transitional dynamics in non-linear macro models has been to employ linear approximations. This raises the central question of this paper: How reliable is this procedure in evaluating the dynamic adjustments to policy changes or structural shocks? This question is significant since one of the basic objectives of contemporary micro-based macroeconomic models is the analysis of intertemporal welfare. We analyze this issue in the context of a neoclassical Ramsey growth model, with two alternative specifications of productive government spending, by employing both linearization and non-linear solution techniques. We find that 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. In contrast, if government expenditure assumes the form of a stock, leading to more sluggish adjustment, linearization is more problematic. The linearization procedure may yield misleading predictions, both qualitatively and quantitatively. These occur at the beginning of the transition and therefore weigh heavily in intertemporal welfare calculations. These patterns are verified for temporary shocks as well.

Keywords: Public expenditure; growth; nonlinearities; welfare analysis (search for similar items in EconPapers)
JEL-codes: E62 O41 (search for similar items in EconPapers)
Pages: 46
Date: 2008-01, Revised 2008-09
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
References: Add references at CitEc
Citations: View citations in EconPapers (10)

Downloads: (external link)
https://coss.fsu.edu/econpapers/wpaper/wp2008_11_01.pdf First version, 2008-01 (application/pdf)

Related works:
Journal Article: How misleading is linearization? Evaluating the dynamics of the neoclassical growth model (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fsu:wpaper:wp2008_11_01

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Working Papers from Department of Economics, Florida State University Contact information at EDIRC.
Bibliographic data for series maintained by Luke Rodgers ().