Practical tools for policy analysis in DSGE models with missing channels

By Dario Caldara, Richard Harrison and Anna Lipinska

In this paper we analyze the propagation of shocks originating in sectors that are not present in a baseline dynamic stochastic general equilibrium (DSGE) model. Specifically, we proxy the missing sector through a small set of factors, that feed into the structural shocks of the DSGE model to create correlated disturbances. We estimate the factor structure by matching impulse responses of the augmented DSGE model to those generated by an auxiliary model. We apply this methodology to track the effects of oil shocks and housing demand shocks in models without energy and housing sectors.

I have selected this paper because I very it very intriguing, in a too-good-to-be-true way. Suppose you have estimated a New-Keynesian model that comes down to three equations. You want to add shocks that have not been considered in the estimation. This paper suggest a way to add these shocks without touching the initial estimates, which you cannot re-estimate anyway for identification reasons. In other words, this is a procedure that would allow to bypass idenfication issues and add many more shocks. As I said, I am intrigued.

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