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Working Papers

November 1990, No. 90-11

How Well Do Linear Approximation Methods Work? Results for Suboptimal Dynamic Equilibria

Michael Dotsey and Ching-Sheng Mao

Real business cycle models have recently been applied to settings in which equilibria are suboptimal.  In most models the solutions are approximated using some type of linearization with little attention being given to the accuracy of the approximation.  In this paper we investigate three different approximation methods in the context of a neoclassical model with a production tax and compare their solutions with solutions obtained from a discrete state space solution to the Euler equations of the model.   

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