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Dealing with Financial Instability under a DSGE modeling approach with Banking Intermediation: a forecastability analysis versus TVP-VARs

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  • Bekiros, Stelios D.; Cardani, Roberta; Paccagnini, Alessia; Villa, Stefania

Abstract

Recently there has been an increasing awareness on the role that the banking sector can play in macroeconomic activity, especially within the context of the DSGE literature. In this work, we present a DSGE model with financial intermediation as in Gertler and Karadi (2011). The estimation of the shocks and of the structural parameters shows that time-variation can be crucial in the empirical analysis. As DSGE modeling fails to take into account inherent nonlinearities of the economy, we introduce a novel time-varying coefficient state-space estimation method for VAR processes, for homoskedastic and heteroskedastic error structures (TVP-VAR). We conduct an extensive empirical exercise to compare the out-of-sample forecastability of the DSGE model versus standard ARs, VARs, Bayesian VARs and TVP-VARs. We find that the TVP-VAR provides the best forecasting performance for the series of GDP and net worth of financial intermediaries for all steps-ahead, while the DSGE model with the incorporation of a banking sector outperforms the other specifications in forecasting inflation and the federal funds rate at shorter horizons.

Suggested Citation

  • Bekiros, Stelios D.; Cardani, Roberta; Paccagnini, Alessia; Villa, Stefania, 2015. "Dealing with Financial Instability under a DSGE modeling approach with Banking Intermediation: a forecastability analysis versus TVP-VARs," Economics Working Papers ECO2015/04, European University Institute.
  • Handle: RePEc:eui:euiwps:eco2015/04
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    References listed on IDEAS

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    1. Roberta Cardani & Alessia Paccagnini & Stefania Villa, 2015. "Forecasting in a DSGE Model with Banking Intermediation: Evidence from the US," Working Papers 292, University of Milano-Bicocca, Department of Economics, revised Feb 2015.
    2. Marvin Goodfriend & Bennett T. McCallum, 2007. "Banking and interest rates in monetary policy analysis: a quantitative exploration," Proceedings, Federal Reserve Bank of San Francisco.
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    More about this item

    Keywords

    DSGE; Extended Kalman Filter; Financial Frictions; Banking Sector;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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