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DSGE Models and the Lucas critique

  • Samuel Hurtado

    (Banco de España)

Modern DSGE models are microfounded and have deep parameters that should be invariant to changes in economic policy, so in principle they are not subject to the Lucas critique. But the literature has already established that misspecification issues also cause parameter instability after policy changes in DSGE models. This paper will look at the implications of parameter shifts for econometric policy evaluation, to see whether policy advice derived from DSGE models would have differed fundamentally from that which the policymakers of the 1970s derived from their reduced-form Phillips curves. The results show drift in most parameters, including those that are supposedly structural (such as the share of capital in production, habits or the elasticity of labor supply to the real wage), and major shifts in the impulse response functions derived from the real-time estimation of the model. After the expansionary monetary shocks of the early 1970s, a standard DSGE model would have behaved very similarly to an old-style Phillips curve, with marked shifts in parameter values and impulse response functions.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/13/Fich/dt1310e.pdf
File Function: First version, August 2013
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1310.

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Length: 21 pages
Date of creation: Aug 2013
Date of revision:
Handle: RePEc:bde:wpaper:1310
Contact details of provider: Web page: http://www.bde.es/
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  1. Canova, Fabio & Sala, Luca, 2009. "Back to square one: identification issues in DSGE models," CEPR Discussion Papers 7234, C.E.P.R. Discussion Papers.
  2. Cristiano Cantore & Filippo Ferroni & Miguel A León-Ledesma, 2012. "Interpreting the Hours-Technology time-varying relationship," Studies in Economics 1201, School of Economics, University of Kent.
  3. Smets, Frank & Wouters, Raf, 2007. "Shocks and frictions in US business cycles: a Bayesian DSGE approach," Working Paper Series 0722, European Central Bank.
  4. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  5. Yongsung Chang & Sun-Bin Kim & Frank Schorfheide, 2011. "Labor-Market Heterogeneity, Aggregation, and the Policy-(In)variance of DSGE Model Parameters," RCER Working Papers 566, University of Rochester - Center for Economic Research (RCER).
  6. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  7. Inoue, Atsushi & Rossi, Barbara, 2008. "Which Structural Parameters Are "Structural"? Identifying the Sources of Instabilities in Economic Models," Working Papers 08-02, Duke University, Department of Economics.
  8. Aitor Lacuesta & Sergio Puente & Ernesto Villanueva, 2011. "The schooling response to a sustained increase in low-skill wages: evidence from Spain 1989-2009," Banco de Espa�a Working Papers 1208, Banco de Espa�a.
  9. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  10. Cogley Timothy & Yagihashi Takeshi, 2010. "Are DSGE Approximating Models Invariant to Shifts in Policy?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-33, October.
  11. Jürgen Jerger & Oke Röhe, 2012. "Testing for Parameter Stability in DSGE Models. The Cases of France, Germany, Italy, and Spain," Working Papers 118, Bavarian Graduate Program in Economics (BGPE).
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