Dynamic Properties of Two Approximate Solutions to a Particular Growth Model

Abstract

This paper investigates two methods of approximating the optimal decision rules of a stochastic, representative agent model which exhibits growth in steady state and cannot be expressed in linear–quadratic form. Both methods are modifications on the linear quadratic approximation technique proposed by Kydland and Prescott. It is shown that one of the solution methods leads to bizarre dynamic behavior, even with shocks of empirically reasonable magnitude. The other solution technique does not exhibit such bizarre behavior.

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