DP11261 Priors for the Long Run

Author(s): Domenico Giannone, Michele Lenza, Giorgio E Primiceri
Publication Date: May 2016
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11261

We propose a class of prior distributions that discipline the long-run behavior of Vector Autoregressions (VARs). These priors can be naturally elicited using economic theory, which provides guidance on the joint dynamics of macroeconomic time series in the long run. Our priors for the long run are conjugate, and can thus be easily implemented using dummy observations and combined with other popular priors. In VARs with standard macroeconomic variables, a prior based on the long-run predictions of a wide class of dynamic stochastic general equilibrium models yields substantial improvements in the forecasting performance.