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Our most academic publication offers research and surveys on monetary policy, national and international developments, banking, and more. The content is written for an economically informed readership—from the undergraduate student to the PhD.


Vol. 93, No. 3 (Posted 2011-05-01)

Dynamics of Externalities: A Second-Order Perspective

by Yi Wen and Huabin Wu

First-order approximation methods are a standard technique for analyzing the local dynamics of dynamic stochastic general equilibrium (DSGE) models. Although linear methods yield quite accurate solutions for a broad class of DSGE models, some important economic issues (e.g., portfolio choice and welfare) cannot be adequately addressed by first-order methods. This paper provides yet another case when first-order methods may be inadequate for capturing the business cycle properties of a DSGE model.

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