Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153193
Authors: 
Levine, Paul
Pearlman, Joseph G.
Pierse, Richard
Year of Publication: 
2007
Series/Report no.: 
ECB Working Paper 759
Abstract: 
We examine the linear-quadratic (LQ) approximation of non-linear stochastic dynamic optimization problems in macroeconomics, in particular for monetary policy. We make four main contributions: first, we draw attention to a general Hamiltonian framework for LQ approximation due to Magill (1977). We show that the procedure for the ‘large distortions’ case of Benigno and Woodford (2003, 2005) is equivalent to the Hamiltonian approach, but the latter is far easier to implement. Second, we apply the Hamiltonian approach to a Dynamic Stochastic General Equilibrium model with external habit in consumption. Third, we introduce the concept of target-implementability which fits in with the general notion of targeting rules proposed by Svensson (2003, 2005). We derive sufficient conditions for the LQ approximation to have this property in the vicinity of a zero-inflation steady state. Finally, we extend the Hamiltonian approach to a non-cooperative equilibrium in a two-country model.
Subjects: 
dynamic stochastic general equilibrium models
Linear-quadratic approximation
utility-based loss function
JEL: 
E52
E37
E58
Document Type: 
Working Paper

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