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I was going through this paper by Aghion et al. I wanted some clarification on some of the computations. I understood the process uptil the normalization on page 22. Then we can get some policy rules for the economy based on those variables and equations.

I don't precisely know how to proceed from here and it seems like an indication that I am not clear on what I am doing. After they get their policy rules, they go ahead and get optimal long run taxes. I am not sure how I should use my policy rules to get to that result.

Before reading the methodology I would've thought that all we would do was to calculate the steady states of the transformed equations, get some societal welfare function in terms of the transformed stationary equations, and iterate over taxes in the steady state and see what gave us the highest welfare. But the paper seems to want to transform the variables to the untransformed versions before that.

Any help/references would be great. I am using Dynare to solve a very similar problem, but I don't know exactly what to do after I have solved for the policy rules of the transformed variables.

Thanks

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  • $\begingroup$ I'd consider including the computations you're having trouble with in the body of your answer. Also, if your difficulties are mainly with the math (as opposed to econ), you can consider posting them in the math stack exchange. $\endgroup$ – Patricio Jan 29 '19 at 10:25
  • $\begingroup$ Thank you @Patricio . I found out why we would need the policy functions and that is because the paper uses initial conditions of the simulations as the BGP-SS conditions under the case that capital tax = 0. Which means for cases where capital tax != 0, we don't automatically start on BGP. And this in essence under(?)estimates the optimal capital tax rate finally, making the authors' points even stronger. $\endgroup$ – Hariharan Jan 29 '19 at 18:20

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