Welfare analysis, logs-exp() and pruning

Stochastic simulations
1

Hi,

I have a model expressed in logs (using exp()) instead of levels and it is initially estimated in 1st order and it works properly.

The thing is that because i wan’t to make a welfare analysis, from what i have read, i need a 2nd order approximation to both the equilibrium condotion and the welfare criterion, so i try to proceed with 2nd order approximation.

Is it correct to apply it even in logs (leaving the exp()) in each variable or do i need to remove them and have the variables appearing in levels, recalculate the stady state and proceed with the 2nd order approximation?

Finally, in case i apply 2nd order approx. in log variables {exp()} and then because the IRFs are explosive, use Pruning would that be wrong for welfare analysis? My point is that whether Pruning is compatible with welfare analysis.

Kind regards

2

Doing the approximation in logs for welfare analysis is actually standard and not a problem. Pruning is a different issue. I am not aware of any analysis comparing welfare in a pruned and a non-pruned state space.There is indeed some tension when doing welfare analysis in a non-pruned state space and then turning on pruning for IRFs. But my reading of the literature is that this is quite standard.

3

Professor

Thank you very much for your help.