How Useful Are Estimated DSGE Model Forecasts for Central Bankers?

Abstract

Dynamic stochastic general equilibrium (DSGE) models are a prominent tool for forecasting at central banks, and the competitive forecasting performance of these models relative to alternatives, including official forecasts, has been documented. When evaluating DSGE models on an absolute basis, however, we find that the benchmark estimated mediumscale DSGE model forecasts inflation and GDP growth very poorly, although statistical and judgmental forecasts do equally poorly. Our finding is the DSGE model analogue of the literature documenting the recent poor performance of macroeconomic forecasts relative to simple naive forecasts since the onset of the Great Moderation. Although this finding is broadly consistent with the DSGE model we employ-the model itself implies that especially under strong monetary policy, inflation deviations should be unpredictable-a "wrong" model may also have the same implication. We therefore argue that forecasting ability during the Great Moderation is not a good metric by which to judge models. D ynamic stochastic general equilibrium models were descriptive tools at their inception. They were useful because they allowed economists to think about business cycles and carry out hypothetical policy experiments in Lucas critique-proof frameworks. In their early form, however, they were viewed as too minimalist to be appropriate for use in any practical application, such as macroeconomic forecasting, for which a strong connection to the data was needed. The seminal work of Frank Smets and Raf Wouters (2003, 2007) changed this perception. In particular, their demonstration of the possibility of estimating a much larger and more richly specified DSGE model (similar to that developed by Christiano, Eichenbaum, and Evans 2005), as well as

The Accuracy of a Forecast Targeting Central Bank

“…This is because the inflation process has become markedly less persistent than before, and is now dominated by short-run fluctuations. The findings in Edge and Gürkaynak (2010) are in line with this, since they find that their DSGE model is very poor at forecasting US inflation, but so are all the other approaches that they use (uni-and multivariate time series models).…”

“…They also provide the standard baseline in the assesment of the forecasts from DSGE models, see e.g. Edge and Gürkaynak (2010). The results of the comparison are presented in Section 6.3, while Section 7 contains our conclusion.…”

The eyes of the state: how central banks think

“…If the model predicts that policymaker actions are useless, it is no surprise that policymakers were not exactly clamouring to take them on board. A second major reason for the delayed uptake by central banks was that the forecasting record for these models was poor and policymakers preferred models that tracked the data more reliably, even if at the cost of theoretical consistency (Edge and Gürkaynak 2010;Gürkaynak et al 2013). As highly abstract and highly theoretical tools, these models did not offer much help in the crucial task of forecasting.…”

Inflation Prediction and Inflation Volatility for Turkey

“…Basco, D'Amato, and Garegnani (2009) analyze money with price relationship for Argentia and found that money and price relationship holds during high inflationary period. (EDGE & GÜRKAYNAK, 2010), forecast the monetary policy mechanism for Turkey and explain that, inflation deviation are unpredictable for Turkey. Moreover, (DSGE) and Bayesian VAR model proves poor forecasting for the Turkey.…”

“…For this reason, it is not a least demanding task to measure inflation volatility in order to craft systematic behaviour for different market players. Although different studies have been done so for to measure the inflation volatility such as ((EDGE & GÜRKAYNAK, 2010 ;Berument & Sahin, 2010;Berganza & Broto, 2012;Castillo, 2014;Singor, Grzelak, van Bragt, & Oosterlee, 2013;Ginindza & Maasoumi, 2013;Clark & Davig, 2011;Kim, 2004;Castelnuovo, 2010)) that provide an overview and postulate that under unsystematic monetary policy inflation deviation is unpredictable, while for systematic monetary policy, it is desirable to assume that government does not intervene in the monetary policy. In this paper, we choose a mathematical technique to measure inflation volatility and inflation prediction for Turkey.…”