We evaluate the Smets-Wouters model of the US dynamically using indirect inference with a VAR representation of the main US data series. We find that the New Keynesian SW model is badly rejected by the data's dynamic properties and in particular cannot match the variability of the data. An alternative (New Classical) version of the model with flexible wages and prices and a one-period information lag fares no better. A 'weighted' model (mostly NC but part NK) is able to match the data variability, though it too is rejected overall. Allowing for structural breaks in monetary regime we find a model from 1984 onwards fits fairly well dynamically; this has a high NK weight, suggesting much greater nominal stickiness during the 'great moderation'.

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractWith Monte Carlo experiments on models in widespread use we examine the performance of indirect inference (II) tests of DSGE models in small samples. We compare these tests with ones based on direct inference (using the Likelihood Ratio, LR). We …nd that both tests have power so that a substantially false model will tend to be rejected by both; but that the power of the II test is substantially greater, both because the LR is applied after reestimation of the model error processes and because the II test uses the false model's own restricted distribution for the auxiliary model's coe¢ cients. This greater power allows users to focus this test more narrowly on features of interest, trading o¤ power against tractability.JEL Classi…cation: C12, C32, C52, E1

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. This working paper is produced for discussion purpose only. These working papers are expected to be publishedin due course, in revised form, and should not be quoted or cited without the author's written permission. Cardiff Economics Working Papers are available online from: econpapers.repec.org/paper/cdfwpaper/ and business.cardiff.ac.uk/research/academic-sections/economics/working-papers Enquiries: EconWP@cardiff.ac.uk The financial crisis of 2007-2011 has challenged our previous understanding of the monetary system, with its assumptions that asset markets are complete and that money injections work solely through the setting of interest rates on safe short-term government bonds. Instead it now seems more promising to assume that financial assets, and specifically bonds and credit, are imperfect substitutes and that money substitutes with a wide variety of financial and real assets in rather different ways; in such a world we can find a role * Corresponding Author: LeVP@cardiff.ac.uk 1 for Quantitative Easing (QE) -Open Market Operations -that has now become a major instrument of monetary policy. This world harks back to that of Friedman's Quantity Theory restatement (Friedman, 1956) and Brunner and Meltzer's papers on the banking system (e.g. Brunner and Meltzer, 1963) as a transmission mechanism for money. Terms of use: Documents in EconStor mayIn this paper our aim is to construct a DSGE model in which this imperfect substitution occurs between financial assets and in which therefore money has a role beyond merely setting the interest rate on shortterm government bonds, 'bank rate' for short. To do this we borrow from available models of the economy, banking and collateral to create out of them what could be called a 'neo-monetarist' model. Another element we inject is the possibility of hitting the zero bound on the bank rate; we do this quite simply by suspending the Taylor Rule when bank rate solves for this level or below and replacing it with this exogenous lower bound; this does not undermine inflation determinacy because this situation cannot continue indefinitely since the shocks to interest rates must die out in time. We test this model against the key features of US macroeconomic data and compare its performance with other models that do not have these new elements;we find that our augmented model gets somewhat closer to the data's behaviour.The model has clear welfare and policy implications. In the economy there are two main interest rate...

The downturn in the world economy following the global banking crisis has left the Chinese economy relatively unscathed. This paper develops a model of the Chinese economy using a DSGE framework with a banking sector to shed light on this episode. It differs from other applications in the use of indirect inference procedure to test the fitted model. The model finds that the main shocks hitting China in the crisis were international and that domestic banking shocks were unimportant. However, directed bank lending and direct government spending was used to supplement monetary policy to aggressively offset shocks to demand. The model finds that government expenditure feedback reduces the frequency of a business cycle crisis but that any feedback effect on investment creates excess capacity and instability in output.

We review recent findings in the application of indirect inference to DSGE models. We show that researchers should tailor the power of their test to the model under investigation in order to achieve a balance between high power and finding a robust model; this will involve choosing only a limited number of variables on whose behaviour they should focus. Also recent work reveals that it makes little difference which these variables are or how their behaviour is measured whether via a VAR, IRFs or moments. We also review identification issues, how to test part of a model and whether alternative evaluation methods such as forecasting or likelihood ratio tests are potentially helpful.