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Data-Rich DSGE and Dynamic Factor Models

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  • Maxym Kryshko
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    Abstract

    Dynamic factor models and dynamic stochastic general equilibrium (DSGE) models are widely used for empirical research in macroeconomics. The empirical factor literature argues that the co-movement of large panels of macroeconomic and financial data can be captured by relatively few common unobserved factors. Similarly, the dynamics in DSGE models are often governed by a handful of state variables and exogenous processes such as preference and/or technology shocks. Boivin and Giannoni(2006) combine a DSGE and a factor model into a data-rich DSGE model, in which DSGE states are factors and factor dynamics are subject to DSGE model implied restrictions. We compare a data-richDSGE model with a standard New Keynesian core to an empirical dynamic factor model by estimating both on a rich panel of U.S. macroeconomic and financial data compiled by Stock and Watson (2008).We find that the spaces spanned by the empirical factors and by the data-rich DSGE model states are very close. This proximity allows us to propagate monetary policy and technology innovations in an otherwise non-structural dynamic factor model to obtain predictions for many more series than just a handful of traditional macro variables, including measures of real activity, price indices, labor market indicators, interest rate spreads, money and credit stocks, and exchange rates.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 11/216.

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    Length: 49
    Date of creation: 01 Sep 2011
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    Handle: RePEc:imf:imfwpa:11/216

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    Related research

    Keywords: Economic models; inflation; monetary policy; real output; monetary base; monetary economics; price inflation; money balances; money demand; nominal interest rate; real money; gdp deflator; foreign exchange; contractionary monetary policy; central bank; money stock; monetary fund; forecasting inflation; nominal interest rates; aggregate demand; wage inflation; monetary authority; steady-state inflation; high interest rates; money market; terms of trade; monetary policy regime; inflationary expectations; price level; real wages; rates of inflation;

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    Cited by:
    1. Chen, Liang, 2012. "Identifying observed factors in approximate factor models: estimation and hypothesis testing," MPRA Paper 37514, University Library of Munich, Germany.

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