Missing Internal Propagation in Macro Models

Abstract

This paper investigates whether the documented shortcomings of medium-scale DSGE models, as outlined by Beaudry et al. (2020), stem from parameter misspecification or a fundamental absence of endogenous propagation mechanisms. Beaudry et al. (2020) identify that the spectral density of “hours worked” displays two distinct peaks, one at business cycle frequencies and another at lower frequencies. They argue that medium-scale DSGE models fail to accurately capture both the position and magnitude of the spectral density peak at business cycle frequencies, attributing this limitation to insufficient endogenous mechanisms and the restrictive nature of AR(1) shocks. In contrast, we argue, both analytically and through model simulations, that these models can reproduce the spectral density peak at business cycle frequencies when AR(1) shocks are employed, provided there is additional endogenous propagation in labor markets. Importantly, this propagation mechanism has significant implications for counterfactual policy analysis.

Sanjay Moorjani

Contact - moorjani@bc.edu

My research interests include Macroeconomics and Monetary Economics.