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What is the truth about DSGE models? Testing by indirect inference

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This paper addresses the growing gulf between traditional macroeconometrics and the increasingly dominant preference among macroeconomists to use DSGE models and to estimate them using Bayesian estimation with strong priors but not to test them as they are likely to fail conventional statistical tests. This is in conflict with the high scientific ideals with which DSGE models were first invested in their aim of finding true models of the macroeconomy. As macro models are in reality only approximate representations of the economy, we argue that a pseudo-true inferential framework should be used to provide a measure of the robustness of DSGE models.

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  • Meenagh, David & Minford, Patrick & Wickens, Michael & Xu, Yongdeng, 2016. "What is the truth about DSGE models? Testing by indirect inference," Cardiff Economics Working Papers E2016/14, Cardiff University, Cardiff Business School, Economics Section.
    • Handle: RePEc:cdf:wpaper:2016/14
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    1. Vo Le & David Meenagh & Patrick Minford & Zhirong Ou, 2013. "What Causes Banking Crises? An Empirical Investigation for the World Economy," Open Economies Review, Springer, vol. 24(4), pages 581-611, September.
    2. Canova, Fabio & Sala, Luca, 2009. "Back to square one: Identification issues in DSGE models," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 431-449, May.
    3. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
    4. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2012. "What causes banking crises? An empirical investigation," Cardiff Economics Working Papers E2012/14, Cardiff University, Cardiff Business School, Economics Section, revised Apr 2013.
    5. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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    8. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    9. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2016. "Monetarism rides again? US monetary policy in a world of Quantitative Easing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 85-102.
    10. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick & Wickens, Michael, 2011. "How much nominal rigidity is there in the US economy? Testing a new Keynesian DSGE model using indirect inference," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 2078-2104.
    11. Vo Le & David Meenagh & Patrick Minford & Michael Wickens & Yongdeng Xu, 2016. "Testing Macro Models by Indirect Inference: A Survey for Users," Open Economies Review, Springer, vol. 27(1), pages 1-38, February.
    12. Liu, Chunping & Minford, Patrick, 2014. "How important is the credit channel? An empirical study of the US banking crisis," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 119-134.
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    14. Marco Del Negro & Frank Schorfheide, 2004. "Priors from General Equilibrium Models for VARS," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 643-673, May.
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    Cited by:

    1. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick & Wickens, Michael, 2017. "A Monte Carlo procedure for checking identification in DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 202-210.
    2. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2020. "News and why it is not shocking: The role of micro-foundations," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 66(C).

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    More about this item

    Keywords

    Pseudo-true inference; DSGE models; Indirect Inference; Wald tests; Likelihood Ratio tests; robustness;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models

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