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Selecting structural innovations in DSGE models

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  • Filippo Ferroni
  • Stefano Grassi
  • Miguel A. León‐Ledesma

Abstract

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.

Suggested Citation

  • Filippo Ferroni & Stefano Grassi & Miguel A. León‐Ledesma, 2019. "Selecting structural innovations in DSGE models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 34(2), pages 205-220, March.
  • Handle: RePEc:wly:japmet:v:34:y:2019:i:2:p:205-220
    DOI: 10.1002/jae.2664
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    Cited by:

    1. Masaru Inaba & Kengo Nutahara & Daichi Shirai, 2020. "What drives fluctuations of labor wedge and business cycles? Evidence from Japan," CIGS Working Paper Series 20-006E, The Canon Institute for Global Studies.
    2. Stefan Schiman, 2021. "Labor Supply Shocks and the Beveridge Curve: Empirical Evidence from EU Enlargement," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 40, pages 108-127, April.
    3. Giovannini, Massimo & Pfeiffer, Philipp & Ratto, Marco, 2021. "Efficient and robust inference of models with occasionally binding constraints," Working Papers 2021-03, Joint Research Centre, European Commission (Ispra site).

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