A Proposal for a Flexible Trend Specification in DSGE Models

Issue: 2/2016

Martin Slanicay

Masaryk University, Faculty of Economics and Administration, Department of Economics, Lipová 41a, Brno 602 00, slanicay@mail.muni.cz

In this paper I propose a flexible trend specification for estimating DSGE models on log differences. I demonstrate this flexible trend specification on a New Keynesian DSGE model of two economies, which I consequently estimate on data from the Czech economy and the euro area, using Bayesian techniques. The advantage of the trend specification proposed is that the trend component and the cyclical component are modelled jointly in a single model. The proposed trend specification is flexible in the sense that smoothness of the trend can be easily modified by different calibration of some of the trend parameters. The results suggest that this method is capable of finding a very reasonable trend in the data. Moreover, comparison of forecast performance reveals that the proposed specification offers more reliable forecasts than the original variant of the model.

DOI: 10.1515/revecp-2016-0006
JEL: E32, C68, C51
Keywords: trend specification, DSGE model, Bayesian estimation

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