Linear-Quadratic Approximation, Efficiency and Target-Implementability

Paul Levine (), Joseph Pearlman and Richard Pierse

No 441, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: We examine linear-quadratic (LQ) approximation of stochastic dynamic optimization problems in macroeconomics (and elsewhere), in particular in policy analysis using Dynamic Stochastic General Equilibrium (DSGE) models. We first define the problem that is solved by a social planner, given that the objective of the latter is to maximize average welfare; this yields the efficient solution. We then comment on the LQ approximation when a tax or subsidy can be imposed such that the zero-inflation competitive steady state output level is equal to the efficient level. We then examine the correct procedure for replacing a stochastic non-linear dynamic optimization problem with a linear-quadratic approximation. We show that a procedure proposed by Benigno and Woodford (2004) for large underlying distortions in the economy can be more easily implemented through a second-order approximation of the Hamiltonian used to compute the ex ante optimal policy with commitment (the Ramsey problem). We then define the notion of Target-Implementability, which is also a sufficient condition for a particular steady-state maximum of the Ramsey problem, and explain the usefulness of this in the context of stabilization policy

Keywords: Linear-quadratic approximation; dynamic stochastic general equilibrium models; utility-based loss function (search for similar items in EconPapers)
JEL-codes: E37 E52 E58 (search for similar items in EconPapers)
Date: 2006-07-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

Downloads: (external link)
http://repec.org/sce2006/up.25695.1141160133.pdf (application/pdf)

Related works:
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:sce:scecfa:441

Access Statistics for this paper

More papers in Computing in Economics and Finance 2006 from Society for Computational Economics Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().