Taking Trends Seriously in DSGE Models: An Application to the Dutch Economy

90 Pages Posted: 12 Jul 2012

Date Written: July 12, 2012

Abstract

We construct a new-Keynesian DSGE model tailored to the Netherlands and interpret it as a multivariate unobserved components model. We identify three major stochastic trends in the data — trends in general - purpose technology, investment-specific technology, and labor supply — and model them formally in our theoretical set-up. Our trend-cycle decomposition captures the data’s co-integrating properties without which long-run analysis — whether scenario analysis or forecasting — would likely be mis-specified. In particular, this approach appears to produce better-behaved posteriors for parameters along decision margins where traditional modeling imposes highly persistent but temporary shocks. The existence of permanent and temporary disturbances along the same margin broadens the scope for counter-factuals. Specifically, differences in short-run responses to the two types of shocks reflect smoothing motives and discounted valuation effects reminiscent of the Permanent Income Hypothesis.

JEL Classification: C54, E27, E37, E47

Suggested Citation

Lafourcade, Pierre M and de Wind, Joris, Taking Trends Seriously in DSGE Models: An Application to the Dutch Economy (July 12, 2012). De Nederlandsche Bank Working Paper No. 345, Available at SSRN: https://ssrn.com/abstract=2104141 or http://dx.doi.org/10.2139/ssrn.2104141

Pierre M Lafourcade (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Joris de Wind

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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