Variance Decomposition Analysis for Nonlinear DSGE Models: An Application with ZLB

In this paper, we propose three methods and algorithms to compute and analyze variance decomposition for nonlinear DSGE models. We also compare these methods using a simple theoretical example. For the empirical illustration, we apply these methods to a standard dynamic New Keynesian (DNK) model with occasionally-binding zero lower bound on nominal interest rates (ZLB). We find that the supply shock becomes significantly less important relative to the demand shock in explaining the volatility of economic variables, especially GDP, at a short horizon when the economy stays at a deep recession with binding ZLB.