Inequality Constraints and Euler Equation-based Solution Methods

Pontus Rendahl*

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

Solving dynamic models with inequality constraints poses a challenging problem for two major reasons: dynamic programming techniques are reliable but often slow, whereas Euler equation-based methods are faster but have problematic or unknown convergence properties. This study attempts to bridge this gap. I show that a common iterative procedure on the first-order conditions - usually referred to as time iteration - delivers a sequence of approximate policy functions that converges to the true solution under a wide range of circumstances. These circumstances extend to a large set of endogenous and exogenous state variables as well as a very broad spectrum of occasionally binding constraints.

Original languageEnglish
JournalEconomic Journal
Volume125
Issue number585
Pages (from-to)1110-1135
Number of pages26
ISSN0013-0133
DOIs
Publication statusPublished - 1 Jun 2015
Externally publishedYes

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