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Linear-quadratic approximation, external habit and targeting rules. (English) Zbl 1181.91143
Summary: We examine the linear-quadratic approximation of nonlinear dynamic stochastic optimization problems. A discrete-time version of M. J. P. Magill [J. Econ. Theory 15, 211–219 (1977; Zbl 0382.90028)] is generalized to models with forward-looking variables paying special attention to second-order conditions. This is the “large distortions” case in the literature. We apply the approach to monetary policy in a DSGE model with external habit in consumption. We then develop a condition for “target-implementability”, a concept related to “targeting rules”. Finally, we extend the approach to a comparison between cooperative and non-cooperative equilibria in a two-country model and show that the “small distortions” approximation is inappropriate for this exercise.

91B51 Dynamic stochastic general equilibrium theory
91A10 Noncooperative games
91A12 Cooperative games
91B66 Multisectoral models in economics
Full Text: DOI
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