OLG Life Cycle Model Transition Paths: Alternate Model Forecast Method

Abstract

The overlapping generations (OLG) model is an important framework for analyzing any type of question in which age cohorts are affected differently by exogenous shocks. However, as the dimensions and degree of heterogeneity in these models increase, the computational burden imposed by rational expectations solution methods for non-stationary equilibrium transition paths increases exponentially. As a result, these models have been limited in the scope of their use to a restricted set of applications and a relatively small group of researchers. In addition to providing a detailed description of the benchmark rational expectations computational method, this paper presents an alternative method for solving for nonstationary equilibrium transition paths in OLG life cycle models that is new to this class of model. We find that our alternate model forecast method reduces computation time to 15 percent of the benchmark time path iteration computation time, and the approximation error is less than 1 percent.