Hello everyone, I would like to inquire about the method of welfare analysis. When the literature does welfare analysis, some models are linearized and some models are not. As far as I know, welfare analysis requires a second-order approximation. What kind of form is recommended for welfare analysis? There’s a logarithmic form, a zero exponential form, and a direct linearization form.
If the model is linearized, can we do welfare analysis? It is said that there is a method called linear quadratic method. Does this approach apply if there is both price and wage stickiness in the model.
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Generally, you need a full second order approximation. A linearized model will not do unless the steady state is undistorted. In that case, a naive linear quadratic approach will work.