Dear Dynare Forum,
We have a question regarding second order approximation. How does Dynare make such an approximation? We have written a model in levels and then let Dynare do the second order approximation using the command stoch_simul(order=2,irf=50);
In the model we have a quadratic equation, but for some reason this quadratic equation gives negative IRFs. How is this possible? How can a second order approximation of a quadratic equation be negative?
Attached, you find a simple model in which we highlight our problem. Why does the second order approximation of pi_2, which is a quadratic function, give negative IRFs?
Many thanks for your help.
Dynare_forum.mod (250 Bytes)