DP9056 Testing DSGE models by Indirect inference and other methods: some Monte Carlo experiments

Author(s):	Vo Phuong Mai Le, David Meenagh, Patrick Minford, Michael R. Wickens
Publication Date:	July 2012
Keyword(s):	Bootstrap, DSGE, DSGE-VAR weight, indirect inference, likelihood ratio, New Classical, New Keynesian, Wald statistic
JEL(s):	C12, C32, C52, E1
Programme Areas:	International Macroeconomics
Link to this Page:	www.cepr.org/active/publications/discussion_papers/dp.php?dpno=9056

Using Monte Carlo experiments, we examine the performance of Indirect Inference tests of DSGE models, usually versions of the Smets-Wouters New Keynesian model of the US postwar period. We compare these with tests based on direct inference (using the Likelihood Ratio), and on the Del Negro-Schorfheide DSGE-VAR weight. We find that the power of all three tests is substantial so that a false model will tend to be rejected by all three; but that the power of the indirect inference tests are by far the greatest, necessitating re-estimation by indirect inference to ensure that the model is tested in its fullest sense.