Solving dynamic general equilibrium models using a second-order approximation to the policy function

This paper derives a second-order approximation to the solution of a general class of discrete-time rational expectations models. The main theoretical contribution is to show that for any model belonging to that class, the coefficients on the terms linear and quadratic in the state vector in a second-order expansion of the decision rule are independent of the volatility of the exogenous shocks. In addition, the paper presents a set of MATLAB programs that implement the proposed second-order approximation method and applies it to a number of model economies. (C) 2003 Elsevier B.V. All rights reserved.