Chari, Kehoe and McGrattan (2007) (CKM) show that a large class of dynamic stochastic general equilibrium (DSGE) models with various frictions and shocks is observationally equivalent to a benchmark real business cycle (RBC) model with correlated "wedges" in the RBC model's first-order conditions. The wedges in the static first-order conditions of the RBC model can be readily computed by evaluating the first-order conditions at the data and then solving for the wedges. In contrast, identification of the "investment wedge" in the RBC model's dynamic Euler equation requires the researcher to make assumptions about the expectation formation by agents in the RBC model. In particular, CKM assume that expectations are formed as if, from the perspective of the model's agents, wedges followed a vector autoregressive process of order one (VAR(1)). We show that wedges generally do not have a VAR(1) representation, implying that CKM's procedure is based on model-inconsistent expectations. We also provide an alternative, model-consistent approach to modeling expectation formation. On the former issue, we present a necessary and sufficient ``rank condition'' under which a detailed economy can be mapped into a benchmark model where wedges follow a VAR(1) process. On the latter issue, we suggest that the information set underlying the expectation formation should not only contain current wedges, but also all predetermined variables.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Universitaet Bern, Departement Volkswirtschaft in its series Diskussionsschriften with number
dp0705.
Find related papers by JEL classification: C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
This paper has been announced in the following NEP Reports:
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2007.
"Business Cycle Accounting,"
Econometrica,
Econometric Society, vol. 75(3), pages 781-836, 05.
[Downloadable!] (restricted)
Other versions:
V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2006.
"Business cycle accounting,"
Staff Report
328, Federal Reserve Bank of Minneapolis.
[Downloadable!]
V.V. Chari & Patrick J. Kehoe & Ellen McGrattan, 2004.
"Business Cycle Accounting,"
NBER Working Papers
10351, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)