Discussion of Marco del Negro and Frank Schorfheide

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Discussion of Marco del Negro and Frank
SchorfheideMonetary Policy Analysis with
Potentially Misspecified Models

• Ramon Marimon
• Universitat Pompeu Fabra CREi, Barcelona
• (visiting Ente Einaudi and Luiss University,
  Rome)
• Monetary policy and imperfect knowledge
• ECB conference 
• Würzburg, 14-15 October 2004
•  

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A Discussion in honor of The 2004 Nobel
Laureates in Economic Science!Finn E. Kydland
Edward C. Prescott
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What
  padre teorico della Banca Centrale
Europea (Sole 24 Ore, Ocotber 12, 2004) 
would say?
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The 1st that Ed would say is
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(No Transcript)
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With probability .73 the discussion would end
here!
Today the efficient lottery results in
continuation
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The 2nd

• Of course, 1995 Nobel Laureate Robert Lucas is
  right,
• but the issue between DSGE models and VARs
• is not the Lucas critique
• Its, as 1975 Nobel Laureate Tjalling Koopmanss,
  said
• avoid measurement without theory
• and Ed adds
• constraint theory by data facts
• the minimal SVAR theory is not
• a beautiful theory (as RBC can be)

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What is a beautiful theory?1979 Physics Nobel
Laureate Steven Weinberg asks, and
says (proper Nobel Laureates only quote other
Nobel Laureates!)

• Simplicity is part of what I mean by beauty, but
  it is a simplicity of ideas...
• We are on the track of something universal ()
  We do not want to discover a theory that is
  capable of describing all imaginable kinds of
  force among particles of nature. Rather we hope
  for a theory that rigidly will allow us to
  describe only those forces gravitational,
  electroweak, and strong that actually, as it
  happens, do exist. This kind of rigidity in our
  physical theories is part of what we recognize as
  beauty. (Dreams of a Final Theory)

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Are Del Negro Schorfheilde building on a
beautiful theory?
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• In every period a fraction of firms is unable to
  re-optimize their prices
• Households preferences display habit persistence
• The preference shifters
• Households choose capital utilization and pay a
  cost of utilization
• Stochastic disturbance to the price of investment
• In every period a fraction of households is
  unable to re-adjust their wages
• There is a complete set of contingent securities
  in nominal terms
• The central bank follows a nominal interest rate
  rule
• At time T the policymaker seeks to replace the
  existing policy rule

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The 3rd

• Progress, dont disperse!

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The 4th

• Watch your language!
• What do you mean by complete markets here?
• What is your commodity space?
• What monetary/banking model do you have?

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The 5th

• Set an explicit Recursive Dynamic Stochastic
  General Equilibrium Model!
• Derive agents and policy rules as functions of
  the state variables!
• Then,
• you can talk more properly of a
• misspecified model
• -are we missing a state variable?
• -are we constraining policy rules?
• -do agents Perceived Law of Motion
• differ from the Actual Law of Motion?
• sorry, this is not Eds language!

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Del Negro Schorfheilde misspecification
DSGE
Is this a DSGE?
Misspecified DSGE
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Can we deconstruct?

• Where is the misspecification in the original
  model?
• Are we missing a state variable?
• Does the AR representation of decision rules
  require long lags?
• The hyperparameter ?, determining the length
  of the sample scales the variance of the the
  discrepancy. Large values of ?, correspond to
  small model misspecification
• with small ? you are likely to misspecify your
  decision rules! (Chari-Kehoe-McGrattan dixit)

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How do Del Negro Schorfheilde proceed?

• We begin with a direct estimation of the DSGE
  model using Bayesian techniques
• We will construct a prior that has the property
  that its density is proportional to the expected
  likelihood ratio of

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The 6th
Calibrate, dont Bayess!
a Minnesota discussion with
will follow
It will be
truly misspecified
inarticulate and
suddenly interrupted!
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...only understood by
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and Ed, looking
would say
The 7th!
Dont you have a problem with your Likelihood
being too flat?
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and Del Negro Schorfheilde

• We conclude that over the range of historical
  sample the DSGE model is strongly dominated by
  the DSGE-VARs with intermediate values of ?
  indicating that the structural model is to some
  extent misspecified

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Ed would say The 8th
(from an Arizona Sunset)

• Misspecified or

Mesmerized?
Why dont you check first your DSGE-VARs with the
data generated by the DSGE as those guys, still
at Minnesota, do?
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But Nobel Laureates must behave!
(well, some appear in airline comercials, others
write non-sense anti-G books!)
The 9th
Whats the point?
(Lucas would say Where is the meat?)
That while the DSGE may recommend a stronger
response to inflation movements, the better fit
(optimal) misspecified DSGE-VAR will not
recommend a strong response, when the
policymaker allows for more feedback from
sample information (Scenarios 3 4)?
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(No Transcript)
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Finally, being here, the  padre teorico della
Banca Centrale Europea would conclude
The 10th The ECB should

• definitively use rules rather than discretion
• follow the scientific method for policy design
• support economics science research
• (as the Mpls FED!)

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And Ed, the now proper Nobel Laureate,
would say

• Thank you!