DP9663 Solving and Estimating Indeterminate DSGE Models

Author(s): Roger E A Farmer, Vadim Khramov
Publication Date: September 2013
Keyword(s): Bayesian estimation, Dynare, indeterminacy
JEL(s): C11, C13, C54
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9663

We propose a method for solving and estimating linear rational expectations models that exhibit indeterminacy and we provide step-by-step guidelines for implementing this method in the Matlab-based packages Dynare and Gensys. Our method redefines a subset of expectational errors as new fundamentals. This redefinition allows us to treat indeterminate models as determinate and to apply standard solution algorithms. We provide a selection method, based on Bayesian model comparison, to decide which errors to pick as fundamental and we present simulation results to show how our procedure works in practice.