DP11817 What is the truth about DSGE models? Testing by indirect inference

Author(s): David Meenagh, Patrick Minford, Michael R. Wickens, Yongdeng Xu
Publication Date: January 2017
Keyword(s): DSGE models, indirect inference, Likelihood Ratio tests, Pseudo-true inference, robustness, Wald tests
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11817

This paper addresses the growing gulf between traditional macroeconometrics and the increasingly dominant preference among macroeconomists to use DSGE models and to estimate them using Bayesian estimation with strong priors but not to test them as they are likely to fail conventional statistical tests. This is in conflict with the high scientific ideals with which DSGE models were first invested in their aim of finding true models of the macroeconomy. As macro models are in reality only approximate representations of the economy, we argue that a pseudo-true inferential framework should be used to provide a measure of the robustness of DSGE models.