Optimal Policy Rules in Rational-Expectations Models: New Solution Algorithms

Abstract

This paper develops methods to solve for optimal discretionary policies and optimal commitment policies in rational expectations models. These algorithms, which allow the optimization constraints to be conveniently expressed in second-order structural form, are more general than existing methods and are simple to apply. We use several New Keynesian business cycle models to illustrate their application. Simulations show that the procedures developed in this paper can quickly solve small-scale models and that they can be usefully and effectively applied to medium- and large-scale models.