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Informing DSGE Models Through Dynamic Factor Models

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  • Mario Forni
  • Luca Gambetti
  • Marco Lippi
  • Luca Sala

Abstract

Structural dynamic factor models (SDFM) represent a reliable tool to inform the construction of dynamic stochastic general equilibrium (DSGE) models. The reason is that the log‐linear solution of a DSGE model has a factor structure which ensures consistency between the representations of the two models. We assess the usefulness of SDFM for DSGE analysis by means of simulations. Using a standard DSGE model as the data generating process, we show that the factor model always provides accurate estimates of the impulse response functions. As an application, we reassess the literature studying the response of hours to technology shock. An additional application studies the effects of monetary policy.

Suggested Citation

  • Mario Forni & Luca Gambetti & Marco Lippi & Luca Sala, 2025. "Informing DSGE Models Through Dynamic Factor Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 40(5), pages 487-507, August.
    • Handle: RePEc:wly:japmet:v:40:y:2025:i:5:p:487-507
    DOI: 10.1002/jae.3122
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