Challenges for Central Banks' Macro Models

90 Pages Posted: 25 Jul 2016

See all articles by Jesper Lindé

Jesper Lindé

Sveriges Riksbank

Frank Smets

European Central Bank (ECB); KU Leuven - Center for Economic Studies

Rafael Wouters

National Bank of Belgium

Date Written: July 2016

Abstract

In this paper we discuss a number of challenges for structural macroeconomic models in the light of the Great Recession and its aftermath. It shows that a benchmark DSGE model that shares many features with models currently used by central banks and large international institutions has difficulty explaining both the depth and the slow recovery of the Great Recession. In order to better account for these observations, the paper analyses three extensions of the benchmark model. First, we estimate the model allowing explicitly for the zero lower bound constraint on nominal interest rates. Second, we introduce time-variation in the volatility of the exogenous disturbances to account for the non-Gaussian nature of some of the shocks. Third and finally, we extend the model with a financial accelerator and allow for time-variation in the endogenous propagation of financial shocks. All three extensions require that we go beyond the linear Gaussian assumptions that are standard in most policy models. We conclude that these extensions go some way in accounting for features of the Great Recession and its aftermath, but they do not suffice to address some of the major policy challenges associated with the use of non-standard monetary policy and macroprudential policies.

Keywords: and VAR models, DSGE, Financial Frictions, great recession, macroprudential policy, Monetary policy, Open economy., Regime-Switching, zero lower bound

JEL Classification: E52, E58

Suggested Citation

Lindé, Jesper and Smets, Frank and Wouters, Rafael, Challenges for Central Banks' Macro Models (July 2016). CEPR Discussion Paper No. DP11405, Available at SSRN: https://ssrn.com/abstract=2814080

Jesper Lindé (Contact Author)

Sveriges Riksbank

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

Frank Smets

European Central Bank (ECB) ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany
+49 69 1344 6550 (Phone)
+49 69 1344 6575 (Fax)

KU Leuven - Center for Economic Studies ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

Rafael Wouters

National Bank of Belgium ( email )

Brussels, B-1000
Belgium
+32 2 221 5441 (Phone)
+32 2 221 3162 (Fax)

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