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MACROPRUDENTIAL POLICY AND FORECASTING USING HYBRID DSGE MODELS WITH FINANCIAL FRICTIONS AND STATE SPACE MARKOV-SWITCHING TVP-VARS

Published online by Cambridge University Press:  17 June 2014

Stelios D. Bekiros  and
Alessia Paccagnini
Stelios D. Bekiros*
Affiliation:
European University Institute, Rimini Centre for Economic Analysis and Athens University of Economics and Business
Alessia Paccagnini
Affiliation:
Università degli Studi di Milano-Bicocca
*
Address correspondence to: Stelios Bekiros, Department of Economics, Via della Piazzuola 43, I-50133, Florence, Italy; e-mail: [email protected].
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Abstract

We focus on the interaction of frictions both at the firm level and in the banking sector in order to examine the transmission mechanism of the shocks and to reflect on the response of the monetary policy to increases in interest rate spreads, using DSGE models with financial frictions. However, VAR models are linear and the solutions of DSGEs are often linear approximations; hence they do not consider time variation in parameters that could account for inherent nonlinearities and capture the adaptive underlying structure of the economy, especially in crisis periods. A novel method for time-varying VAR models is introduced. As an extension to the standard homoskedastic TVP-VAR, we employ a Markov-switching heteroskedastic error structure. Overall, we conduct a comparative empirical analysis of the out-of-sample performance of simple and hybrid DSGE models against standard VARs, BVARs, FAVARs, and TVP-VARs, using data sets from the U.S. economy. We apply advanced Bayesian and quasi-optimal filtering techniques in estimating and forecasting the models.

Keywords

Financial FrictionsTime-Varying CoefficientsQuasi-optimal Filtering
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Issue 7 , October 2015 , pp. 1565 - 1592
Copyright
Copyright © Cambridge University Press 2014 

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