Computing Markov-perfect optimal policies in business-cycle models

Dennis, R. and Kirsanova, T. (2016) Computing Markov-perfect optimal policies in business-cycle models. Macroeconomic Dynamics, 20(7), pp. 1850-1872. (doi: 10.1017/S1365100515000176)

104469.pdf - Accepted Version



Time inconsistency is an essential feature of many policy problems. This paper presents and compares three methods for computing Markov-perfect optimal policies in stochastic nonlinear business cycle models. The methods considered include value function iteration, generalized Euler equations, and parameterized shadow prices. In the context of a business cycle model in which a fiscal authority chooses government spending and income taxation optimally, although lacking the ability to commit, we show that the solutions obtained using value function iteration and generalized Euler equations are somewhat more accurate than that obtained using parameterized shadow prices. Among these three methods, we show that value function iteration can be applied easily, even to environments that include a risk-sensitive fiscal authority and/or inequality constraints on government spending. We show that the risk-sensitive fiscal authority lowers government spending and income taxation, reducing the disincentive to accumulate wealth that households face.

Item Type:Articles
Glasgow Author(s) Enlighten ID:Kirsanova, Professor Tatiana and Dennis, Professor Richard
Authors: Dennis, R., and Kirsanova, T.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Macroeconomic Dynamics
Publisher:Cambridge University Press
ISSN (Online):1469-8056
Published Online:28 September 2015
Copyright Holders:Copyright © 2015 Cambridge University Press
First Published:First published in Macroeconomics Dynamics 20(7): 1850-1872
Publisher Policy:Reproduced in accordance with the copyright policy of the publisher

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