On the application and use of DSGE models
Published in Journal of Economic Dynamics and Control, 2008
(with Pedro Alvarez-Lois, Laura Piscitelli and Alasdair Scott)
A large literature discusses the theory and fit of DSGE models. However, comparatively little has been written on the application and use of DSGE models, especially on the communication of analysis based on such models to policymakers. We argue that this issue deserves more attention.
To put our claim in context, we describe the ‘core/non-core’ approach used in the Bank of England’s Quarterly Model, and compare it with two others: the ‘measurement error’ approach of Ireland and the ‘shocks-in-parameters’ approach utilised by Smets and Wouters and others. Using a mock forecast scenario for illustration, we argue that each of these approaches would present model users with difficulties in communicating with policymakers. We conjecture that it is this problem, not theory or fitting the data, that currently hinders more widespread influence of DSGE-type models on policy-making.