Selecting structural innovations in DSGE models

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DOI

  • Filippo Ferroni, Federal Reserve Bank of Chicago
  • ,
  • Stefano Grassi
  • Miguel A. León-Ledesma, Kent University

Dynamic stochastic general equilibrium (DSGE) models are typically estimated assuming the existence of certain structural shocks that drive macroeconomic fluctuations. We analyze the consequences of estimating shocks that are “nonexistent” and propose a method to select the economic shocks driving macroeconomic uncertainty. Forcing these nonexisting shocks in estimation produces a downward bias in the estimated internal persistence of the model. We show how these distortions can be reduced by using priors for standard deviations whose support includes zero. The method allows us to accurately select shocks and estimate model parameters with high precision. We revisit the empirical evidence on an industry standard medium-scale DSGE model and find that government and price markup shocks are innovations that do not generate statistically significant dynamics.

Original languageEnglish
JournalJournal of Applied Econometrics
Volume34
Issue2
Pages (from-to)205-220
Number of pages16
ISSN0883-7252
DOIs
Publication statusPublished - Mar 2019
Externally publishedYes

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