DP14140 Checking if the Straitjacket Fits

Author(s): Adrian Pagan, Michael R. Wickens
Publication Date: November 2019
Keyword(s): DSGE models, Model testing, SVARs
JEL(s): C52, E3
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14140

This paper discusses, and provides new evidence on, the view that "theory, while essential, should be regarded as a flexible framework rather than a straightjacket, because features that the theory abstracts from may be important in practice". It considers how best to assess the empirical performance of tightly specified models such as DSGE models, and loosely specified models such as SVARs. These issues are illustrated using various New Keynesian models. We conclude that the challenge is to incorporate flexibility into the theory in such a way as to be compatible with both the theory and the data.