Should Central Banks Worry About Nonlinearities of their Large-Scale Macroeconomic Models?

Vadym Lepetyuk, Lilia Maliar & Serguei Maliar
How wrong could policymakers be when using linearized solutions to their macroeconomic models instead of nonlinear global solutions? This question became of much practical interest during the Great Recession and the recent zero lower bound crisis. We assess the importance of nonlinearities in a scaled-down version of the Terms of Trade Economic Model (ToTEM), the main projection and policy analysis model of the Bank of Canada. In a meticulously calibrated “baby” ToTEM model with 21...
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