Deterministic simulations for scenarios

Perfect foresight simulations
1

Dear Community:
I have a basic NK model with government. In this model I want to study different scenarios:

  1. A temporal increase in government spending g today (or in a specific period, say in period 9 only)
  2. A permanent increase in government spending g today (or in a specific period, say from period 9 onwards)
  3. Different combination of funding. For example if I have [\tau_{c} = 0.1, bonds=B/Y] change to another vector.
  4. Change Investment to a specific ratio of GDP
  5. Convergence to net balance to a specific ratio of GDP (in a specific horizon)

Iā€™m a newbie at DSGE, so I want to learn how I could do these types of scenarios. I understand they are deterministic changes to fiscal policy. I should mention that I do include stochastic shocks to the economy as well.

Best,
Rodrigo

1 Like
2

Is your model linearized or solved at first order? In that case, you can ignore the stochastics due to certainty equivalence and conduct a perfect foresight exercise.

3

Yeah, linearized! Okay, that is great to know. In that case, If allow for other shocks like TFP shocks, should I still ignore the stochastic shocks? Do you have any examples of both types of shocks being implemented at the same time?

Thanks

4

There is no point in having the other shocks. They will not affect anything.

5

I see, thanks. This means I need to read more about DSGE solutions under both types. Any recommended literature on this?

6

Not really. Perfect foresight is straightforward solving a deterministic equation system with known shocks. The important insight for stochastic simulations is the certainty equivalence at first order: the shock distributions do not affect the decision rules. When you leave out shocks from the model, it will not affect the reaction of the model variables to the remaining shocks in the model at all.