DP9049 | How Useful are DSGE Macroeconomic Models for Forecasting?

Author(s)

Publication Date

08/07/2012

JEL Code(s)

Keyword(s)

Programme Area(s)

Network(s)

Abstract

We find that forecasts from DSGE models are not more accurate than either times series models or official forecasts, but neither are they any worse. We also find that all three types of forecast failed to predict the recession that started in 2007 and continued to forecast poorly even after the recession was known to have begun. We investigate why these results occur by examining the structure of the solution of DSGE models and compare this with pure time series models. We show that the main factor is the dynamic structure of DSGE models. Their backward-looking dynamics gives them a similar forecasting structure to time series models and their forward-looking dynamics, which consists of expected values of future exogenous variables, is difficult to forecast accurately. As a result we suggest that DSGE models should not be tested through their forecasting ability.