Quantitative Macroeconomics Working Paper Series Solution of Perfect Foresight Saddlepoint Problems: a Simple Method and Applications Solution of Perfect Foresight Saddlepoint Problems: a Simple Method and Applications

Economists frequently connne themselves to the qualitative analysis of continuous optimization problems or they restrict their quantitative analysis to inaccurate methods like lineariza-tion around the steady state. The fact that the solution is characterized by an inherently unstable adjustment path arriving at a boundary value in innnite time, however, does not necessarily imply a complicated solution method. The paper explains and demonstrates the method of backward integration, a recursive solution method that does not only reveal the exact adjustment path but that is also very easy to use. Economists frequently connne themselves to the qualitative analysis of continuous optimization problems or they restrict their quantitative analysis to inaccurate methods like lineariza-tion around the steady state. The fact that the solution is characterized by an inherently unstable adjustment path arriving at a boundary value in innnite time, however, does not necessarily imply a complicated solution method. The paper explains and demonstrates the method of backward integration, a recursive solution method that does not only reveal the exact adjustment path but that is also very easy to use.