By Tom Holden and Michael Paetz
This paper presents a fast, simple and intuitive algorithm for simulation of linear dynamic stochastic general equilibrium models with inequality constraints. The algorithm handles both the computation of impulse responses, and stochastic simulation, and can deal with arbitrarily many bounded variables. To illustrate the usefulness and efficiency of this algorithm we provide two applications according to the zero lower bound (ZLB) on nominal interest rates. Our solution principle is much faster than comparable methods. We therefore expect this algorithm to be very helpful also for estimation procedures, and for a wide range of applications apart from monetary policy analysis.
At least since some countries have been stuck at close to zero interest rates, inequality constraints have become an important issue in macroeconomics. Of course, model solutions based on linearization cannot take inequality conditions, and this paper shows a way around the issue that an in particular be implemented in DYNARE. But I remain unconvinced that this beats a higher order approximation.