Fundamental shock selection in DSGE models

Stefano Grassi (stefano.grassi@uniroma2.it), Miguel Leon-Ledesma and Filippo Ferroni

No 47, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: DSGE models are typically estimated assuming the existence of certain structural or fundamental shocks that drive macroeconomic fluctuations. We analyze the consequences of introducing shocks that are non-fundamental for the estimation of DSGE model parameters. We then propose a method to select the structural shocks driving macroeconomic uncertainty. We show that forcing the existence of non-fundamental structural shocks produces a downward bias in the estimated internal persistence of the model. We then show how these distortions can be reduced by allowing the covariance matrix of the structural shocks to be rank deficient using priors for standard deviations whose support includes zero. The method allows us to accurately select fundamental shocks and estimate model parameters with precision. Finally, we revisit the empirical evidence on an industry standard medium-scale DSGE model model and find that government, price, and wage markup shocks are non-fundamental.

Date: 2016
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (7)

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Related works:
Working Paper: Fundamental shock selection in DSGE models (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:47

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