Challenges for Central Banks’ Macro Models

Riksbank Research Paper Series No. 147

Sveriges Riksbank Working Paper Series No. 323

88 Pages Posted: 23 May 2016

See all articles by Jesper Lindé

Jesper Lindé

Sveriges Riksbank - Research Division

Frank Smets

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

Rafael Wouters

National Bank of Belgium

Date Written: May 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: Monetary policy, DSGE, and VAR models, Regime-Switching, Zero Lower Bound, Financial Frictions, Great Recession, Macroprudential policy, Open economy

JEL Classification: E52, E58

Suggested Citation

Linde, Jesper and Smets, Frank and Wouters, Rafael, Challenges for Central Banks’ Macro Models (May 2016). Riksbank Research Paper Series No. 147. Available at SSRN: https://ssrn.com/abstract=2780455 or http://dx.doi.org/10.2139/ssrn.2780455

Jesper Linde (Contact Author)

Sveriges Riksbank - Research Division ( email )

S-103 37 Stockholm
Sweden
+46 8 787 0873 (Phone)

HOME PAGE: http://www.riksbank.com

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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