Merging simulation and projection approaches to solve high‐dimensional problems with an application to a new Keynesian model

Abstract

We introduce a numerical algorithm for solving dynamic economic models that merges stochastic simulation and projection approaches: we use simulation to approximate the ergodic measure of the solution, we cover the support of the constructed ergodic measure with a fixed grid, and we use projection techniques to accurately solve the model on that grid. The construction of the grid is the key novel piece of our analysis: we replace a large cloud of simulated points with a small set of “representative” points. We present three alternative techniques for constructing representative points: a clustering method, an ε‐distinguishable set method, and a locally‐adaptive variant of the ε‐distinguishable set method. As an illustration, we solve one‐ and multi‐agent neoclassical growth models and a large‐scale new Keynesian model with a zero lower bound on nominal interest rates. The proposed solution algorithm is tractable in problems with high dimensionality (hundreds of state variables) on a desktop computer.