Selecting structural innovations in DSGE models. (5th November 2018)

• Record Type: Journal Article
• Authors: Ferroni, Filippo; Grassi, Stefano; León‐Ledesma, Miguel A.
• Is Part Of: Journal of applied econometrics. Volume 34:Number 2(2019)
• Page Start: 205
• Page End: 220
• Publication Date: 2018-11-05
• Subjects: Econometrics -- Periodicals; 330.015195
• DOI: 10.1002/jae.2664
• Languages: English
• ISSNs: 0883-7252

Abstract

Summary: 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.