Stochastic Growth Model

KoenVermeylen
TheStochasticGrowthModel
Downloadfreebooksat
The Stochastic Growth Model

2
Contents
1. Introduction
2. The stochastic growth model
3. The steady state
4. Linearization around the balanced growth path
5. Solution of the linearized model
6. Impulse response functions
7. Conclusions
Appendix A
A1. The maximization problem of the representative rm
A2. The maximization problem of the representative household
Appendix B
Appendix C
C1. The linearized production function
C2. The linearized law of motion of the capital stock
C3. The linearized rst-order condotion for the rms labor demand
C4. The linearized rst-order condotion for the rms capital demand
C5. The linearized Euler equation of the representative household
C6. The linearized equillibrium condition in the goods market
References
Contents

3
4
7
8
9
13
18
20
20
20
22
24
24
25
26
26
28
30
32
WHATS MISSING IN THIS EQUATION?
MAERSK INTERNATIONAL TECHNOLOGY & SCIENCE PROGRAMME
You could be one of our future talents
Are you about to graduate as an engineer or geoscientist? Or have you already graduated?
If so, there may be an exciting future for you with A.P. Moller - Maersk.
www.maersk.com/mitas
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

3
Introduction
1. Introduction
This article presents the stochastic growth model. The stochastic growth model
is a stochastic version of the neoclassical growth model with microfoundations,
1
and provides the backbone of a lot of macroeconomic models that are used in
modern macroeconomic research. The most popular way to solve the stochastic
growth model, is to linearize the model around a steady state,
2
and to solve the
linearized model with the method of undetermined coecients. This solution
method is due to Campbell (1994).
The set-up of the stochastic growth model is given in the next section. Section 3
solves for the steady state, around which the model is linearized in section 4. The
linearized model is then solved in section 5. Section 6 shows how the economy
responds to stochastic shocks. Some concluding remarks are given in section 7.

4
The representative rm Assume that the production side of the economy
is represented by a representative rm, which produces output according to a
Cobb-Douglas production function:
Y
t
= K
t
(A
t
L
t
)
1
with 0 < < 1 (1)
Y is aggregate output, K is the aggregate capital stock, L is aggregate labor
supply and A is a technology parameter. The subscript t denotes the time period.
The aggregate capital stock depends on aggregate investment I and the depreci-
ation rate :
K
t+1
= (1 )K
t
+I
t
with 0 1 (2)
2. The stochastic growth model
The productivity parameter A follows a stochastic path with trend growth g and
an AR(1) stochastic component:
ln A
t
= ln A
t
+

A
t
A
t
=
A

A
t1
+
A,t
with |
A
| < 1 (3)
A
t
= A
t1
(1 +g)
The stochastic shock
A,t
is i.i.d. with mean zero.
The goods market always clears, such that the rm always sells its total pro-
duction. Taking current and future factor prices as given, the rm hires labor
and invests in its capital stock to maximize its current value. This leads to the
following rst-order-conditions:
3
(1 )
Y
t
L
t
= w
t
(4)
1 = E
t
_
1
1 +r
t+1
Y
t+1
K
t+1
_
+E
t
_
1
1 +r
t+1
_
(5)
According to equation (4), the rm hires labor until the marginal product of
labor is equal to its marginal cost (which is the real wage w). Equation (5) shows
that the rms investment demand at time t is such that the marginal cost of
investment, 1, is equal to the expected discounted marginal product of capital at
time t + 1 plus the expected discounted value of the extra capital stock which is
left after depreciation at time t + 1.
The stochastic growth model

5
The government The government consumes every period t an amount G
t
,
which follows a stochastic path with trend growth g and an AR(1) stochastic
component:
ln G
t
= ln G
t
+

G
t
G
t
=
G

G
t1
+
G,t
with |
G
| < 1 (6)
G
t
= G
t1
(1 +g)
The stochastic shock
G,t
is i.i.d. with mean zero.
A
and
G
are uncorrelated
at all leads and lags. The government nances its consumption by issuing public
debt, subject to a transversality condition,
4
and by raising lump-sum taxes.
5
The
timing of taxation is irrelevant because of Ricardian Equivalence.
6
www.job.oticon.dk
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

6
The representative household There is one representative household, who
derives utility from her current and future consumption:
U
t
= E
t
_

s=t
_
1
1 +
_
st
ln C
s
_
with > 0 (7)
The parameter is called the subjective discount rate.
Every period s, the household starts o with her assets X
s
and receives interest
payments X
s
r
s
. She also supplies L units of labor to the representative rm, and
therefore receives labor income w
s
L. Tax payments are lump-sum and amount to
T
s
. She then decides how much she consumes, and how much assets she will hold
in her portfolio until period s + 1. This leads to her dynamic budget constraint:
X
s+1
= X
s
(1 +r
s
) +w
s
L T
s
C
s
(8)
We need to make sure that the household does not incur ever increasing debts,
which she will never be able to pay back anymore. Under plausible assumptions,
this implies that over an innitely long horizon the present discounted value of
the households assets must be zero:
lim
s
E
t
__
s
=t
1
1 +r
s
_
X
s+1
_
= 0 (9)
This equation is called the transversality condition.
The household then takes X
t
and the current and expected values of r, w, and T
as given, and chooses her consumption path to maximize her utility (7) subject
to her dynamic budget constraint (8) and the transversality condition (9). This
leads to the following Euler equation:
7
1
C
s
= E
s
_
1 +r
s+1
1 +
1
C
s+1
_
(10)
Equilibrium Every period, the factor markets and the goods market clear. For
the labor market, we already implicitly assumed this by using the same notation
(L) for the representative households labor supply and the representative rms
labor demand. Equilibrium in the goods market requires that
Y
t
= C
t
+I
t
+G
t
(11)
Equilibrium in the capital market follows then from Walras law.

7
Let us now derive the models balanced growth path (or steady state); variables
evaluated on the balanced growth path are denoted by a

.
To derive the balanced growth path, we assume that by sheer luck
A,t
=

A
t
=
G,t
=

G
t
= 0, t. The model then becomes a standard neoclassical growth
model, for which the solution is given by:
8
Y
t
=
_

r
+
_
1
A
t
L (12)
K
t
=
_

r
+
_ 1
1
A
t
L (13)
I
t
= (g +)
_

r
+
_ 1
1
A
t
L (14)
C
t
=
_
1 (g +)

r
+
_ _

r
+
_
1
A
t
L G
t
(15)
w
t
= (1 )
_

r
+
_
1
A
t
(16)
r
= (1 +)(1 +g) 1 (17)

3. The steady state
The steady state
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

8
Let us now linearize the model presented in section 2 around the balanced growth
path derived in section 3. Loglinear deviations from the balanced growth path
are denoted by a(so that

X = lnX ln X
).
Below are the loglinearized versions of the production function (1), the law of
motion of the capital stock (2), the rst-order conditions (4) and (5), the Euler
equation (10) and the equilibrium condition (11):
9
Y
t
=

K
t
+ (1 )

A
t
(18)
K
t+1
=
1
1 +g
K
t
+
g +
1 +g
I
t
(19)
Y
t
= w
t
(20)
E
t
_
r
t+1
r
1 +r
_
=
r
+
1 +r
_
E
t
(
Y
t+1
) E
t
(

K
t+1
)
_
(21)
4. Linearization around the balanced growth path
C
t
= E
t
_
C
t+1
_
E
t
_
r
t+1
r
1 +r
_
(22)
Y
t
=
C
t
Y
C
t
+
I
t
Y
I
t
+
G
t
Y
G
t
(23)
The loglinearized laws of motion of A and G are given by equations (3) and (6):
A
t+1
=
A

A
t
+
A,t+1
(24)
G
t+1
=
G

G
t
+
G,t+1
(25)
Linearization around the balanced growth path

9
I now solve the linearized model, which is described by equations (18) until (25).
First note that

K
t
,

A
t
and

G
t
are known in the beginning of period t:

K
t
depends
on past investment decisions, and

A
t
and

G
t
are determined by current and past
values of respectively
A
and
G
(which are exogenous).

K
t
,

A
t
and

G
t
are
therefore called period ts state variables. The values of the other variables in
period t are endogenous, however: investment and consumption are chosen by
the representative rm and the representative household in such a way that they
maximize their prots and utility (
I
t
and

C
t
are therefore called period ts control
variables); the values of the interest rate and the wage are such that they clear
the capital and the labor market.
Solving the model requires that we express period ts endogenous variables as
functions of period ts state variables. The solution of

C
t
, for instance, therefore
looks as follows:
C
t
=
CK

K
t
+
CA

A
t
+
CG

G
t
(26)
The challenge now is to determine the -coecients.
First substitute equation (26) in the Euler equation (22):
CK

K
t
+
CA

A
t
+
CG

G
t
= E
t
_
CK

K
t+1
+
CA

A
t+1
+
CG

G
t+1
_
E
t
_
r
t+1
r
1 +r
_
(27)
Now eliminate E
t
[(r
t+1
r
)/(1+r
)] with equation (21), and use equations (18),

(24) and (25) to eliminate

Y
t+1
,

A
t+1
and

G
t+1
in the resulting expression. This
5. Solution of the linearized model
Solution of the linearized model

10
leads to a relation between period ts state variables, the -coecients and

K
t+1
:
CK

K
t
+
CA

A
t
+
CG

G
t
=
_
CK
+ (1 )
r
+
1 +r
_

K
t+1
+
_
CA
(1 )
r
+
1 +r
A

A
t
+
CG
G

G
t
(28)
We now derive a second relation between period ts state variables, the -coecients
and

K
t+1
: rewrite the law of motion (19) by eliminating

I
t
with equation (23);
eliminate

Y
t
and

C
t
in the resulting equation with the production function (18)
and expression (26); note that I
= K
(g + ); and note that (1 )/(1 + g) +

(Y
t
)/(K
t
(1 +g)) = (1 +r
)/(1 +g). This yields:
K
t+1
=
_
1 +r
1 +g

C
(1 +g)
CK
_

K
t
+
_
(1 )Y
(1 +g)

C
(1 +g)
CA
_

A
t

_
G
(1 +g)
+
C
(1 +g)
CG
_

G
t
(29)
Substituting equation (29) in equation (28) to eliminate

K
t+1
yields:
CK

K
t
+
CA

A
t
+
CG

G
t
=
_
CK
+ (1 )
r
+
1 +r
_ _
1 +r
1 +g

C
(1 +g)
CK
_

K
t
+
_
CK
+ (1 )
r
+
1 +r
_ _
(1 )Y
(1 +g)

C
(1 +g)
CA
_

A
t
CK
+ (1 )
r
+
1 +r
_ _
G
(1 +g)
+
C
(1 +g)
CG
_

G
t
+
_
CA
(1 )
r
+
1 +r
A

A
t

CG
G

G
t
(30)
As this equation must hold for all values of

K
t
,

A
t
and

G
t
, we nd the following
system of three equations and three unknowns:
CK
=
_
CK
+ (1 )
r
+
1 +r
_ _
1 +r
1 +g

C
(1 +g)
CK
_
(31)
CA
=
_
CK
+ (1 )
r
+
1 +r
_ _
(1 )Y
(1 +g)

C
(1 +g)
CA
_
+
_
CA
(1 )
r
+
1 +r
A
(32)
CG
=
_
CK
+ (1 )
r
+
1 +r
_ _
G
(1 +g)
+
C
(1 +g)
CG
_
CG
G
(33)

11
Now note that equation (31) is quadratic in
CK
:
Q
0
+Q
1
CK
+Q
2
2
CK
= 0 (34)
where Q
0
= (1 )
r
+
1+g
, Q
1
= (1 )
r
+
1+r
t
K
t
(1+g)

r
g
1+g
and Q
2
=
C
t
K
t
(1+g)
This quadratic equation has two solutions:
CK1,2
=
Q
1

_
Q
2
1
4Q
0
Q
2
2Q
2
(35)
It turns out that one of these two solutions yields a stable dynamic system, while
the other one yields an unstable dynamic system. This can be recognized as
follows.
Recall that there are three state variables in this economy: K, A and G. A
and G may undergo shocks that pull them away from their steady states, but
as |
A
| and |
G
| are less than one, equations (3) and (6) imply that they are
always expected to converge back to their steady state values. Let us now look
at the expected time path for K, which is described by equation (29). If K is not
at its steady state value (i.e. if

K = 0), K is expected to converge back to its
steady state value if the absolute value of the coecient of

K
t
in equation (29),
1+r
1+g

C
(1+g)
CK
, is less than one; if |
1+r
1+g

C
(1+g)
CK
| > 1,

K is expected to
increase - which means that K is expected to run away along an explosive path,
ever further away from its steady state.
its an interesting world
Get under the skin of it.
Graduate opportunities
Cheltenham | 24,945 + benefits
One of the UKs intelligence services, GCHQs role is two-fold:
to gather and analyse intelligence which helps shape Britains
response to global events, and, to provide technical advice for the
protection of Government communication and information systems.
In doing so, our specialists in IT, internet, engineering, languages,
information assurance, mathematics and intelligence get well
beneath the surface of global affairs. If you thought the world was
an interesting place, you really ought to explore our world of work.
www.careersinbritishintelligence.co.uk
Applicants must be British citizens. GCHQ values diversity and welcomes applicants from
all sections of the community. We want our workforce to reflect the diversity of our work.
TOP
GOVERNMENT
EMPLOYER
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

12
CG
=
_
CK
+ (1 )
r
+
1+r
_
G
(1+g)
1 +
_
CK
+ (1 )
r
+
1+r
_
C
(1+g)

G
(38)
We now have found all the -coecients of equation (26), so we can compute
C
t
from period ts state variables

K
t
,

A
t
and

G
t
. Once we know

C
t
, the other
endogenous variables can easily be found from equations (18), (19), (20), (21)
and (23). The values of the state variables in period t +1 can be computed from
equation (29), and equations (3) and (6) (moved one period forward).
Now note that equation (31) is quadratic in
CK
:
Q
0
+Q
1
CK
+Q
2
2
CK
= 0 (34)
where Q
0
= (1 )
r
+
1+g
, Q
1
= (1 )
r
+
1+r
t
K
t
(1+g)

r
g
1+g
and Q
2
=
C
t
K
t
(1+g)
This quadratic equation has two solutions:
CK1,2
=
Q
1

_
Q
2
1
4Q
0
Q
2
2Q
2
(35)
It turns out that one of these two solutions yields a stable dynamic system, while
the other one yields an unstable dynamic system. This can be recognized as
follows.
Recall that there are three state variables in this economy: K, A and G. A
and G may undergo shocks that pull them away from their steady states, but
as |
A
| and |
G
| are less than one, equations (3) and (6) imply that they are
always expected to converge back to their steady state values. Let us now look
at the expected time path for K, which is described by equation (29). If K is not
at its steady state value (i.e. if

K = 0), K is expected to converge back to its
steady state value if the absolute value of the coecient of

K
t
in equation (29),
1+r
1+g

C
(1+g)
CK
, is less than one; if |
1+r
1+g

C
(1+g)
CK
| > 1,

K is expected to
increase - which means that K is expected to run away along an explosive path,
ever further away from its steady state.

13
We now calibrate the model by assigning appropriate values to , , , A
t
, G
t
,
A
,
G
, g and L. Let us assume, for instance, that every period corresponds
to a quarter, and let us choose parameter values that mimic the U.S. economy:
= 1/3, = 2.5%,
A
= 0.5,
G
= 0.5, and g = 0.5%; A
t
and L are normalized
to 1; G
t
is chosen such that G
t
/Y
t
= 20%; and is chosen such that r
= 1.5%.
11
It is then straightforward to compute the balanced growth path: Y
t
= 2.9,
K
t
= 24.1, I
t
= 0.7, C
t
= 1.6 and w
t
= 1.9 (while r
= 1.5% per construction).

Y
, K
, I
, C
and w
all grow at rate 0.5% per quarter, while r
remains
constant over time. Note that this parameterization yields an annual capital-
output-ratio of about 2, while C and I are about 55% and 25% of Y , respectively
- which seem reasonable numbers. Once we have computed the steady state, we
can use equations (36), (37) and (38) to compute the -coecients. We are then
ready to trace out the economys reaction to shocks in A and G.
Consider rst the eect of a technology shock in quarter 1. Suppose the economy
is initially moving along its balanced growth path (such that

K
s
=

A
s
=

G
s
= 0
s < 1), when in quarter 1 it is suddenly hit by a technology shock
A,1
= 1.
From equation (3) follows then that

A
1
= 1 as well, while equations (29) and
(6) imply that

K
1
=

G
1
= 0. Given these values for quarter 1s state variables
and given the -coecients,

C
1
can be computed from equation (26); the other
endogenous variables in quarter 1 follow from equations (18), (19), (20), (21)
and (23). Quarter 2s state variables can then be computed from equations (28),
(3) and (6) - which leads to the values for quarter 2s endogenous variables,
and quarter 3s state variables. In this way, we can trace out the eect of the
technology shock into the innite future.
6. Impulse response functions
Impulse response functions

14
Figure 1: Eect of a 1% shock in A ...
0
0.05
0.10
0.15
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

K
0
0.2
0.4
0.6
0.8
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

Y
0
0.05
0.10
0.15
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

C
0
1
2
3
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

I
0
0.2
0.4
0.6
0.8
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on w
0.5
0
0.5
1.0
1.5
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on E(r) r


15
Figure 2: Eect of a 1% shock in G ...
0.04
0.03
0.02
0.01
0
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

K
0.015
0.010
0.005
0
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

Y
0.04
0.03
0.02
0.01
0
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

C
0.8
0.6
0.4
0.2
0
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on

I
0.015
0.010
0.005
0
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on w
0
0.04
0.08
0.12
0 4 8 12 16 20 24 28 32 36 40
in %
quarter
... on E(r) r


16
Figure 1 shows how the economy reacts during the rst 40 quarters. Note that
Y jumps up in quarter 1, together with the technology shock. As a result, the
representative household increases her consumption, but as she wants to smooth
her consumption over time, C increases less than Y . Investment I therefore
initially increases more than Y . As I increases, the capital stock K gradually
increases as well after period 1. The expected rate of return, E(r), is at rst higher
than on the balanced growth path (thanks to the technology shock). However,
as the technology shock dies out while the capital stock builds up, the expected
interest rate rapidly falls and even becomes negative after a few quarters. The real
wage w follows the time path of Y . Note that all variables eventually converge
back to their steady state values.
Consider now the eect of a shock in government expenditures in quarter 1.
Assume again that the economy is on a balanced growth path in quarter 0. In
quarter 1, however, the economy is hit by a shock in government expenditures
G,1
= 1. From equation (3) follows then that

A
1
= 1 as well, while equations
(29) and (6) imply that

K
1
=

G
1
= 0. Once we know the state variables in
quarter 1, we can compute the endogenous variables in quarter 1 and the state
variables for quarter 2 in the same way as in the case of a technology shock -
which leads to the values for quarter 2s endogenous variables and quarter 3s
state variables, and so on until the innite future.

IOII7O.. L.I`LI.I
In Paris or Online
International programs taught by professors and professionals from all over the world
BBA in Global Business
MBA in International Management / International Marketing
DBA in International Business / International Management
MA in International Education
MA in Cross-Cultural Communication
MA in Foreign Languages
Innovative Practical Flexible Affordable
Visit: www.HorizonsUniversity.org
Write: Admissions@horizonsuniversity.org
Call: 01.42.77.20.66 www.HorizonsUniversity.org
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

17
Figure 2 shows the economys reaction to a shock in government expenditures
during the rst 40 quarters. As G increases, E(r) increases as well such that C
and I fall (to make sure that C+I +G remains equal to Y , which does not change
in quarter 1 as

K
1
= 0). As I falls, the capital stock K gradually decreases after
period 1, such that Y starts decreasing after period 1 as well. In the meantime,
however, the shock in G is dying out, so after a while E(r) decreases again. As a
result, C and I recover - and as I recovers, K and Y recover also. Note that the
real wage w again follows the time path of Y . Eventually, all variables converge
back to their steady state values.

18
This note presented the stochastic growth model, and solved the model by rst
linearizing it around a steady state and by then solving the linearized model with
the method of undetermined coecients.
Even though the stochastic growth model itself might bear little resemblance to
7. Conclusions
the real world, it has proven to be a useful framework that can easily be extended
to account for a wide range of macroeconomic issues that are potentially impor-
tant. Kydland and Prescott (1982) introduced labor/leisure-substitution in the
stochastic growth model, which gave rise to the so-called real-business-cycle liter-
ature. Greenwood and Human (1991) and Baxter and King (1993) replaced the
lump-sum taxation by distortionary taxation, to study how taxes aect the be-
havior of rms and households. In the beginning of the 1990s, researchers started
introducing money and nominal rigidities in the model, which gave rise to New
Keynesian stochastic dynamic general equilibrium models that are now widely
used to study monetary policy - see Goodfriend and King (1997) for an overview.
Vermeylen (2006) shows how the representative household can be replaced by a
large number of households to study the eect of job insecurity on consumption
and saving in a general equilibrium setting.
Conclusions
Develop the tools we need for Life Science
Masters Degree in Bioinformatics
Bioinformatics is the
exciting eld where biology,
computer science, and
mathematics meet.
We solve problems from
biology and medicine using
methods and tools from
computer science and
mathematics.
Read more about this and our other international masters degree programmes at www.uu.se/master
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

19
1
Microfoundations means that the objectives of the economic agents are formulated ex-
plicitly, and that their behavior is derived by assuming that they always try to achieve
their objectives as well as they can.
2
A steady state is a condition in which a number of key variables are not changing. In the
stochastic growth model, these key variables are for instance the growth rate of aggregate
production, the interest rate and the capital-output-ratio.
3
See appendix A for derivations.
4
This means that the present discounted value of public debt in the distant future should
be equal to zero, such that public debt cannot keep on rising at a rate that is higher
than the interest rate. This guarantees that public debt is always equal to the present
discounted value of the governments future primary surpluses.
5
Lump-sum taxes do not aect the rst-order conditions of the rms and the households,
and therefore do not aect their behavior either.
6
Ricardian equivalence is the phenomenon that - given certain assumptions - it turns out
to be irrelevant whether the government nances its expenditures by issuing public debt
or by raising taxes. The reason for this is that given the time path of government expen-
ditures, every increase in public debt must sooner or later be matched by an increase in
taxes, such that the present discounted value of the taxes which a representative house-
hold has to pay is not aected by the way how the government nances its expenditures -
which implies that her current wealth and her consumption path are not aected either.
7
See appendix A for the derivation.
8
See appendix B for the derivation.
9
See appendix C for the derivations.
10
The solution with unstable dynamics not only does not make sense from an economic
point of view, it also violates the transversality conditions.
11
Note that these values imply that the annual depreciation rate, the annual growth rate
and the annual interest rate are about 10%, 2% and 6%, respectively.
Conclusions

20
The maximization problem of the rm can be rewritten as:
V
t
(K
t
) = max
{L
t
,I
t
}
_
Y
t
w
t
L
t
I
t
+E
t
_
1
1 +r
t+1
V
t+1
(K
t+1
)
__
(A.1)
s.t. Y
t
= K
t
(A
t
L
t
)
1
K
t+1
= (1 )K
t
+I
t
The rst-order conditions for L
t
, respectively I
t
, are:
(1 )K
t
A
1
t
L
t
w
t
= 0 (A.2)
1 +E
t
_
1
1 +r
t+1
V
t+1
(K
t+1
)
K
t+1
_
= 0 (A.3)
In addition, the envelope theorem implies that
V
t
(K
t
)
K
t
= K
1
t
(A
t
L
t
)
1
+ E
t
_
1
1 +r
t+1
V
t+1
(K
t+1
)
K
t+1
_
(1 ) (A.4)
Substituting the production function in (A.2) gives equation (4):
(1 )
Y
t
L
t
= w
t
Substituting (A.3) in (A.4) yields:
V
t
(K
t
)
K
t
= K
1
t
(A
t
L
t
)
1
+ (1 )
Moving one period forward, and substituting again in (A.3) gives:
1 +E
t
_
1
1 +r
t+1
_
K
1
t+1
(A
t+1
L
t+1
)
1
+ (1 )
_
_
= 0
Substituting the production function in the equation above and reshuing leads to equa-
tion (5):
1 = E
t
_
1
1 +r
t+1
Y
t+1
K
t+1
_
+E
t
_
1
1 +r
t+1
_
The maximization problem of the household can be rewritten as:
U
t
(X
t
) = max
{C
t
}
_
ln C
t
+
1
1 +
E
t
[U
t+1
(X
t+1
)]
_
(A.5)
s.t. X
t+1
= X
t
(1 +r
t
) +w
t
L T
t
C
t
Appendix A
A1. The maximization problem of the representative rm
Appendix A

21
The rst-order condition for C
t
is:
1
C
t
1
1 +
E
t
_
U
t+1
(X
t+1
)
X
t+1
_
= 0 (A.6)
In addition, the envelope theorem implies that
U
t
(X
t
)
X
t
=
1
1 +
E
t
_
U
t+1
(X
t+1
)
X
t+1
(1 +r
t
)
_
(A.7)
Substituting (A.6) in (A.7) yields:
U
t
(X
t
)
X
t
= (1 +r
t
)
1
C
t
Moving one period forward, and substituting again in (A.6) gives the Euler equation
(10):
1
C
t
E
t
_
1 +r
t+1
1 +
1
C
t+1
_
= 0
Appendix A
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

22
If C grows at rate g, the Euler equation (10) implies that
C
s
(1 +g) =
1 +r
1 +
C
s
Rearranging gives then the gross real rate of return 1 +r
:
1 +r
= (1 +g)(1 +)
which immediately leads to equation (17).
Subsituting in the rms rst-order condition (5) gives:
t+1
K
t+1
= r
+
Using the production function (1) to eliminate Y yields:
K
1
t+1
(A
t+1
L)
1
= r
+
Rearranging gives then the value of K
t+1
:
K
t+1
=
_

r
+
_ 1
1
A
t+1
L
which is equivalent to equation (13).
Appendix B
Appendix B

23
Substituting in the production function (1) gives then equation (12):
Y
t
=
_

r
+
_
1
A
t
L
Substituting (12) in the rst-order condition (4) gives equation (16):
w
t
= (1 )
_

r
+
_
1
A
t
Substituting (13) in the law of motion (2) yields:
_

r
+
_ 1
1
A
t+1
L = (1 )
_

r
+
_ 1
1
A
t
L +I
t
such that I
t
is given by:
I
t
=
_

r
+
_ 1
1
A
t+1
L (1 )
_

r
+
_ 1
1
A
t
L
=
_

r
+
_ 1
1
[(1 +g) (1 )] A
t
L
= (g +)
_

r
+
_ 1
1
A
t
L
...which is equation (14).
Consumption C
can then be computed from the equilibrium condition in the goods

market:
C
t
= Y
t
I
t
G
t
=
_

r
+
_
1
A
t
L (g +)
_

r
+
_ 1
1
A
t
L G
t
=
_
1
g +
r
+
_ _

r
+
_
1
A
t
L G
t
Now recall that on the balanced growth path, A and G grow at the rate of technological
progress g. The equation above then implies that C
also grows at the rate g, such that

our initial educated guess turns out to be correct.
Appendix B

24
The production function is given by equation (1):
Y
t
= K
t
(A
t
L
t
)
1
Appendix C
C1. The linearized production function
Taking logarithms of both sides of this equation, and subtracting from both sides their
values on the balanced growth path (taking into account that

L
t
= 0), immediately yields
the linearized version of the production function:
ln Y
t
= ln K
t
+ (1 ) ln A
t
+ (1 ) ln L
t
ln Y
t
ln Y
t
= (ln K
t
ln K
t
) + (1 )(ln A
t
ln A
t
) + (1 )(ln L
t
ln L
t
)
Y
t
=

K
t
+ (1 )

A
t
Appendix C
Join the Vestas
Graduate Programme
Experience the Forces of Wind
and kick-start your career
As one of the world leaders in wind power solu-
tions with wind turbine installations in over 65
countries and more than 20,000 employees
globally, Vestas looks to accelerate innovation
through the development of our employees skills
and talents. Our goal is to reduce CO
2
emissions
dramatically and ensure a sustainable world for
future generations.
Read more about the Vestas Graduate
Programme on vestas.com/jobs.
Application period will open 15 September.
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

25
The law of motion of the capital stock is given by equation (2):
K
t+1
= (1 )K
t
+I
t
values on the balanced growth path, yields:
ln K
t+1
ln K
t+1
= ln {(1 )K
t
+I
t
} ln K
t+1
Now take a rst-order Taylor-approximation of the right-hand-side around lnK
t
= ln K
t
and lnI
t
= ln I
t
:
ln K
t+1
ln K
t+1
=
1
(ln K
t
ln K
t
) +
2
(ln I
t
ln I
t
)
K
t+1
=
1

K
t
+
2
I
t
(C.1)
where
1
=
_
ln {(1 )K
t
+I
t
}
ln K
t
_
2
=
_
ln {(1 )K
t
+I
t
}
ln I
t
_
1
and
2
can be worked out as follows:
1
=
_
ln {(1 )K
t
+I
t
}
K
t
K
t
ln K
t
_
=
_
1
(1 )K
t
+ I
t
K
t
_
=
_
1
K
t+1
K
t
_
=
1
1 +g
...as K
t
grows at rate g on the balanced growth path
2
=
_
ln {(1 )K
t
+I
t
}
I
t
I
t
ln I
t
_
C2. The linearized law of motion of the capital stock

=
_
1
(1 )K
t
+ I
t
I
t
_
=
_
1
K
t+1
I
t
_
=
g +
1 +g
...as I
t
/K
t
= g + and K
t
grows at rate g on the balanced growth path
Substituting in equation (C.1) gives then the linearized law of motion for K:
K
t+1
=
1
1 +g
K
t
+
g +
1 +g
I
t
Appendix C

26
The rst-order condition for the rms labor demand is given by equation (4):
(1 )
Y
t
L
t
= w
t
values on the balanced growth path (taking into account that

L
t
= 0), immediately yields
the linearized version of this rst-order condition:
ln (1 ) + ln Y
t
ln L
t
= ln w
t
(ln Y
t
ln Y
t
) (ln L
t
ln L
) = ln w
t
ln w
Y
t
= w
t
C4. The linearized rst-order condition for the rms capital de-
mand
The rst-order condition for the rms capital demand is given by equation (5):
1 = E
t
[Z
t+1
] (C.2)
with Z
t+1
=
1
1+r
t+1
Y
t+1
K
t+1
+
1
1+r
t+1
(C.3)
Now take a rst-order Taylor-approximation of the right-hand-side of equation (C.3)
around lnY
t+1
= ln Y
t+1
, ln K
t+1
= ln K
t+1
and r
t+1
= r
:
Z
t+1
= 1 +
1
(ln Y
t+1
ln Y
t+1
) +
2
(ln K
t+1
ln K
t+1
) +
3
(r
t+1
r
)
= 1 +
1
Y
t+1
+
2

K
t+1
+
3
(r
t+1
r
) (C.4)
C3. The linearized rst-order condotion for the rms labor demand
C4. The linearized rst-order condotion for the rms capital demand
Appendix C

27
where
1
=
_
_
_
1
1+r
t+1
Y
t+1
K
t+1
+
1
1+r
t+1
_
ln Y
t+1
_
_
2
=
_
_
_
1
1+r
t+1
Y
t+1
K
t+1
+
1
1+r
t+1
_
ln K
t+1
_
_
3
=
_
_
_
1
1+r
t+1
Y
t+1
K
t+1
+
1
1+r
t+1
_
r
t+1
_
_
1
,
2
and
3
1
=
_
_
_
1
1+r
t+1
Y
t+1
K
t+1
+
1
1+r
t+1
_
Y
t+1
Y
t+1
ln Y
t+1
_
_
=
_
1
1 +r
t+1
1
K
t+1
Y
t+1
_
=
r
+
1 +r
...using the fact that Y
t+1
= (r
+)K
t+1
2
=
_
_
_
1
1+r
t+1
Y
t+1
K
t+1
+
1
1+r
t+1
_
K
t+1
K
t+1
ln K
t+1
_
_
=
_
1
1 +r
t+1
Y
t+1
K
2
t+1
K
t+1
_
=
r
+
1 +r
...using the fact that Y
t+1
= (r
+)K
t+1
3
=
_
1
(1 +r
t+1
)
2
_
Y
t+1
K
t+1
+ 1
__
=
1
1 +r
(C.5)
Substituting in equation (C.4) gives then:
Z
t+1
= 1 +
r
+
1 +r
Y
t+1

r
+
1 +r
K
t+1

r
t+1
r
1 +r
Substituting in equation (C.2) and rearranging, gives then equation (21):

E
t
_
r
t+1
r
1 +r
_
=
r
+
1 +r
_
E
t
(
Y
t+1
) E
t
(

K
t+1
)
_
Appendix C

28
The Euler equation of the representative household is given by equation (10), which is
equivalent to:
1 = E
t
[Z
t+1
] (C.6)
with Z
t+1
=
1+r
t+1
1+
C
t
C
t+1
(C.7)
Now take a rst-order Taylor-approximation of the right-hand-side of equation (C.7)
around lnC
t+1
= ln C
t+1
, ln C
t
= ln C
t
and r
t+1
= r
:
Z
t+1
= 1 +
1
(ln C
t+1
ln C
t+1
) +
2
(ln C
t
ln C
t
) +
3
(r
t+1
r
)
= 1 +
1

C
t+1
+
2

C
t
+
3
(r
t+1
r
) (C.8)
where
1
=
_
_
_
1+r
t+1
1+
C
t
C
t+1
_
ln C
t+1
_
_
2
=
_
_
_
1+r
t+1
1+
C
t
C
t+1
_
ln C
t
_
_
3
=
_
_
_
1+r
t+1
1+
C
t
C
t+1
_
r
t+1
_
_
1
,
2
and
3
1
=
_
_
_
1+r
t+1
1+
C
t
C
t+1
_
C
t+1
C
t+1
ln C
t+1
_
_
=
_
1 +r
t+1
1 +
C
t
C
2
t+1
C
t+1
_
= 1
2
=
_
_
_
1+r
t+1
1+
C
t
C
t+1
_
C
t
C
t
ln C
t
_
_
=
_
1 +r
t+1
1 +
1
C
t+1
C
t
_
= 1
3
=
_
1
1 +
C
t
C
t+1
_
=
_
1+r
t+1
1+
C
t
C
t+1
1 +r
t+1
_
C5. The linearized Euler equation of the representative household

Appendix C

29
=
1
1 +r
Substituting in equation (C.8) gives then:

Z
t+1
= 1

C
t+1
+

C
t
+
r
t+1
r
1 +r
Substituting in equation (C.6) and rearranging, gives then equation (22):
C
t
= E
t
_
C
t+1
_
E
t
_
r
t+1
r
1 +r
_
Appendix C
By 2020, wind could provide one-tenth of our planets
electricity needs. Already today, SKFs innovative know-
how is crucial to running a large proportion of the
worlds wind turbines.
Up to 25 % of the generating costs relate to mainte-
nance. These can be reduced dramatically thanks to our
systems for on-line condition monitoring and automatic
lubrication. We help make it more economical to create
cleaner, cheaper energy out of thin air.
By sharing our experience, expertise, and creativity,
industries can boost performance beyond expectations.
Therefore we need the best employees who can
meet this challenge!
The Power of Knowledge Engineering
Brain power
Plug into The Power of Knowledge Engineering.
Visit us at www.skf.com/knowledge
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

30
The equilibrium condition in the goods market is given by equation (11):
Y
t
= C
t
+I
t
+G
t
values on the balanced growth path, yields:
ln Y
t
ln Y
t
= ln (C
t
+I
t
+G
t
) ln Y
t
Now take a rst-order Taylor-approximation of the right-hand-side around lnC
t
= ln C
t
,
ln I
t
= ln I
t
and lnG
t
= ln G
t
:
ln Y
t
ln Y
t
=
1
(ln C
t
ln C
t
) +
2
(ln I
t
ln I
t
) +
3
(ln G
t
ln G
t
)
Y
t
=
1

C
t
+
2
I
t
+
3

G
t
(C.9)
where
1
=
_
ln {C
t
+I
t
+G
t
}
ln C
t
_
2
=
_
ln {C
t
+I
t
+G
t
}
ln I
t
_
3
=
_
ln {C
t
+I
t
+G
t
}
ln G
t
_
1
,
2
and
3
1
=
_
ln {C
t
+I
t
+G
t
}
C
t
C
t
ln C
t
_
=
_
1
C
t
+I
t
+G
t
C
t
_
=
C
t
Y
t
C6. The linearized equillibrium condition in the goods market
Appendix C

31
2
=
_
ln {C
t
+I
t
+G
t
}
I
t
I
t
ln I
t
_
=
_
1
C
t
+I
t
+G
t
I
t
_
=
I
t
Y
3
=
_
ln {C
t
+I
t
+G
t
}
G
t
G
t
ln G
t
_
=
_
1
C
t
+I
t
+G
t
G
t
_
=
G
t
Y
t
Substituting in equation (C.9) gives then the linearized equilibrium condition in the
goods market:
Y
t
=
C
t
Y
C
t
+
I
t
Y
I
t
+
G
t
Y
G
t
Appendix C
Destination MMU
MMU is proud to be one of the most popular universities in the UK.
Some 34,000 students from all parts of the globe select from its
curricula of over 1,000 courses and qualifications.
We are based in the dynamic yet conveniently compact city of Manchester,
located at the heart of a sophisticated transport network including a major
international airport on the outskirts. Parts of the campus are acclaimed for
their architectural style and date back over 150 years, in direct contrast to
our teaching style which is thoroughly modern, innovative and
forward-thinking.
MMU offers undergraduate and postgraduate courses in
the following subject areas:
Art, Design & Performance
Computing, Engineering & Technology
Business & Management
Science, Environmental Studies & Geography
Law, Education & Psychology
Food, Hospitality, Tourism & Leisure Studies
Humanities & Social Science
For more details or an application form
please contact MMU International.
email: international@mmu.ac.uk
telephone: +44 (0)161 247 1022
www.mmu.ac.uk/international
P
l
e
a
s
e

c
l
i
c
k

t
h
e

a
d
v
e
r
t

32
Baxter, Marianne, and Robert G. King (1993), Fiscal Policy in General Equilibrium,
American Economic Review 83 (June), 315-334.
Campbell, John Y. (1994), Inspecting the Mechanism: An Analytical Approach to the
Stochastic Growth Model, Journal of Monetary Economics 33 (June), 463-506.
Goodfriend, Marvin and Robert G. King (1997), The New Neoclassical Synthesis and
the Role of Monetary Policy, in Bernanke, Ben S., and Julio J. Rotemberg, eds., NBER
Macroeconomics Annual 1997, The MIT Press, pp. 231-83.
Greenwood, Jeremy, and Gregory W. Human (1991), Tax Analysis in a Real-Business-
Cycle Model: On Measuring Harberger Triangles and Okun Gaps, Journal of Monetary
Economics 27 (April), 167-190.
Kydland, Finn E., and Edward C. Prescott (1982), Time to Build and Aggregate Fluc-
tuations, Econometrica 50 (Nov.), 1345-1370.
Vermeylen, Koen (2006), Heterogeneous Agents and Uninsurable Idiosyncratic Employ-
ment Shocks in a Linearized Dynamic General Equilibrium Model, Journal of Money,
Credit, and Banking 38, 3 (April), 837-846.
References
References

Stochastic Growth Model

Загружено:

Сведения о документе

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Stochastic Growth Model

Загружено:

Авторское право:

Доступные форматы

KoenVermeylen

= (1 +)(1 +g) 1 (17)

)] with equation (21), and use equations (18),

(g + ); and note that (1 )/(1 + g) +

)/(1 +g). This yields:

= 1.5% per construction).

all grow at rate 0.5% per quarter, while r

Impulse response functions

Impulse response functions

can then be computed from the equilibrium condition in the goods

also grows at the rate g, such that

C2. The linearized law of motion of the capital stock

...using the fact that Y

...using the fact that Y

Substituting in equation (C.2) and rearranging, gives then equation (21):

C5. The linearized Euler equation of the representative household

Substituting in equation (C.8) gives then:

Substituting in equation (C.6) and rearranging, gives then equation (22):

Вам также может понравиться