Department of Economics. University of Melbourne. Parkville Victoria 3052 Australia
ABSTRACT
Two common properities of macroeconomic models are saddle-path instability and the existence of non-linearities. Under these circumstances, a common approach is to make analysis more tactable by linearising the model in the neighbourhood of an appropriate steady-state. The linearised model is then employed to calculate short-run adjustments following exogenous shocks. This can lead to different results than would be derived from the correct (non-linear) model. Iin this paper, we investigate the magnitude of errors that come about as a consequence of using a linear approximation to a well-known optimising model. We do this by taking a calibrated version of the neoclassical adjustment-cost model of investment due to Hayashi (1982).
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