Working Paper: CEPR ID: DP4848
Authors: Marco Del Negro; Frank Schorfheide; Frank Smets; Rafael Wouters
Abstract: The Paper provides new tools for the evaluation of DSGE models, and applies it to a large-scale New Keynesian dynamic stochastic general equilibrium (DSGE) model with price and wage stickiness and capital accumulation. Specifically, we approximate the DSGE model by a vector autoregression (VAR), and then systematically relax the implied cross-equation restrictions. Let delta denote the extent to which the restrictions are being relaxed. We document how the in- and out-of-sample fit of the resulting specification (DSGE-VAR) changes as a function of delta. Furthermore, we learn about the precise nature of the misspecification by comparing the DSGE model?s impulse responses to structural shocks with those of the best-fitting DSGE-VAR. We find that the degree of misspecification in large-scale DSGE models is no longer so large to prevent their use in day-to-day policy analysis, yet it is not small enough that it cannot be ignored.
Keywords: Bayesian analysis; DSGE models; Model evaluation; Vector autoregression
JEL Codes: C11; C32; C53
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| degree of misspecification in large-scale DSGE models (C50) | attention warranted (Y20) |
| DSGE model's impulse responses align closely with those of the best-fitting DSGE-VAR (E13) | DSGE model can effectively capture dynamics of the economy (E13) |
| relaxing the DSGE model restrictions (E13) | improves fit and forecasting performance of the model (C53) |
| posterior distribution of the hyperparameter governing relaxation of restrictions has an inverse U-shape (C46) | some degree of flexibility in model restrictions enhances forecasting accuracy (C53) |
| DSGE-VAR provides a more accurate benchmark for evaluating the dynamics of the DSGE model (E13) | captures responses to monetary policy shocks (E39) |