Working Paper: NBER ID: w17906
Authors: Jon Faust; Abhishek Gupta
Abstract: While dynamic stochastic general equilibrium (DSGE) models for monetary policy analysis have come a long way, there is considerable difference of opinion over the role these models should play in the policy process. The paper develops three main points about assessing the value of these models. First, we document that DSGE models continue to have aspects of crude approximation and omission. This motivates the need for tools to reveal the strengths and weaknesses of the models--both to direct development efforts and to inform how best to use the current flawed models. Second, posterior predictive analysis provides a useful and economical tool for finding and communicating strengths and weaknesses. In particular, we adapt a form of discrepancy analysis as proposed by Gelman, et al. (1996). Third, we provide a nonstandard defense of posterior predictive analysis in the DSGE context against long-standing objections. We use the iconic Smets-Wouters model for illustrative purposes, showing a number of heretofore unrecognized properties that may be important from a policymaking perspective.
Keywords: DSGE Models; Monetary Policy; Posterior Predictive Analysis
JEL Codes: C52; E1; E32; E37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current DSGE models (E13) | important omissions and coarse approximations (C60) |
| important omissions and coarse approximations (C60) | materially impact policymaking (D78) |
| prior and posterior predictive analysis (C11) | assess strengths and weaknesses of DSGE models (E13) |
| prior and posterior predictive analysis (C11) | valuable tools for policymakers (D78) |
| Smets-Wouters model (E17) | properties significant for policymakers (H82) |
| posterior predictive analysis (C59) | practical Bayesian response to inference challenges (C11) |
| DSGE models (E13) | understanding macroeconomic dynamics (E00) |
| DSGE models (E13) | improving policy analysis (D78) |