Policy Analysis Using DSGE Models: An Introduction

21 Pages Posted: 17 Oct 2010

See all articles by Argia M. Sbordone

Argia M. Sbordone

Federal Reserve Bank of New York

Andrea Tambalotti

Federal Reserve Bank of New York

Krishna Rao

Stanford University

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: October 2010

Abstract

Many central banks have come to rely on dynamic stochastic general equilibrium, or DSGE, models to inform their economic outlook and to help formulate their policy strategies. But while their use is familiar to policymakers and academics, these models are typically not well known outside these circles. This article introduces the basic structure, logic, and application of the DSGE framework to a broader public by providing an example of its use in monetary policy analysis. The authors present and estimate a simple New Keynesian DSGE model, highlighting the core features that this basic specification shares with more elaborate versions. They then apply the estimated model to study the sources of the sudden increase in inflation that occurred in the first half of 2004. One important lesson derived from this exercise is that the management of expectations can be a more effective tool for stabilizing inflation than actual movements in the policy rate. This result is consistent with the increasing focus on the pronouncements of central bankers regarding their future actions.

Keywords: DSGE models, Monetary policy

JEL Classification: E31, E52

Suggested Citation

Sbordone, Argia M. and Tambalotti, Andrea and Rao, Krishna and Walsh, Kieran James, Policy Analysis Using DSGE Models: An Introduction (October 2010). Economic Policy Review, Vol. 16, No. 2, October 2010, Available at SSRN: https://ssrn.com/abstract=1692896 or http://dx.doi.org/10.2139/ssrn.1692896

Argia M. Sbordone (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Andrea Tambalotti

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Krishna Rao

Stanford University ( email )

Stanford, CA 94305
United States

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

Santa Barbara, CA

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