Monetary Policy Analysis with Potentially Misspecified Models

Marco Del Negro and Frank Schorfheide
Working Paper 2005-26
December 2005

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The paper proposes a novel method for conducting policy analysis with potentially misspecified dynamic stochastic general equilibrium (DSGE) models and applies it to a New Keynesian DSGE model along the lines of Christiano, Eichenbaum, and Evans (JPE 2005) and Smets and Wouters (JEEA 2003). We first quantify the degree of model misspecification and then illustrate its implications for the performance of different interest rate feedback rules. We find that many of the prescriptions derived from the DSGE model are robust to model misspecification.

JEL classification: C32

Key words: Bayesian analysis, DSGE models, model misspecification

The authors thank Kosuke Aoki, David Arsenau, Jesús Fernández-Villaverde, John Geweke, Lars Hansen, Andrew Levin, Ramon Marimon, Tom Sargent, Peter Summers, Charles Whiteman, and the participants of the 2004 EEA-ESEM session on Empirical Models for Monetary Policy Analysis, the 2004 ECB Conference on Monetary Policy and Imperfect Knowledge, the fall 2004 Macro System Committee meetings, the 2004 Southern Economic Association meetings, the “Macroeconomics and Reality, 25 Years Later” conference at Universitat Pompeu Fabra, the 2005 Conference on Quantitative Evaluation of Stabilization Policies at Columbia University, and seminar participants at the Bank of England, the Kansas City Fed, and the University of Miami for helpful comments. Schorfheide gratefully acknowledges financial support from the Alfred P. Sloan Foundation. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Marco Del Negro, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8561, 404-498-8956 (fax),, or Frank Schorfheide, Department of Economics, University of Pennsylvania, McNeil Building, Room 525, 3718 Locust Walk, Philadelphia, PA 19104-6297, 215-898-8486, 215-573-2057 (fax),