Testing a DSGE Model of the EU Using Indirect Inference
We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data. We find that their model generates excessive variance compared with the data. But their model fits the dynamic facts quite well if the errors have the properties assumed by SW but scaled down. We compare a New Classical version of the model which also performs reasonably if error properties are chosen using New Classical priors (notably excluding shocks to preferences). Both versions have (different) difficulties fitting the data if the actual error properties are used. A model combining rigid and flexible-wage/price sectors, with a weight of around 5% on the rigid sector, does best in fitting the data.
KeywordsBootstrap DSGE model VAR model Model of EU Indirect inference Wald statistic
JEL ClassificationC12 C32
We are grateful for helpful comments on earlier drafts to Matthew Canzoneri, Harris Dellas, Casper de Vries, Alessandro Flamini, Max Gillman, John Hunter, Vo Phuong Mai Le, Adrian Pagan, and Christoph Thoenissen. We also thank Konstantinos Theodoridis for his substantial input in the early stages of this work. None of those mentioned bears any responsibility for errors in the present version of the paper. Our work was supported by the UK Economic and Social Research Council under grant no RES-165-25-0020.
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