Essays on Economic Policy (ESPE in Spanish) - Overcoming the Forecasting Limitations of Forward-Looking Theory Based Models
En la revista Ensayos sobre Política Económica (ESPE) divulgamos los resultados y las propuestas de política que surgen de investigaciones académicas realizadas en el Banco de la República. Cuando nos lea, tenga siempre presente que el contenido de nuestros artículos, así como los análisis y conclusiones que de ellos se derivan, son exclusiva responsabilidad de sus autores. El material divulgado en nuestra revista ESPE no compromete ni representa la opinión del Banco de la República ni la de su Junta Directiva.
Theory-consistent models have to be kept small to be tractable. If they are to forecast well, they have to condition on data that are unmodelled, noisy, patchy and about the future. Agents can also use these data to form their own expectations. In this paper we illustrate a scheme for jointly conditioning the forecasts and internal expectations of linearised forward-looking DSGE models on data through a Kalman Filter fixed-interval smoother. We also trial some diagnostics of this approach, in particular decompositions that reveal when a forecast conditioned on one set of variables implies estimates of other variables which are inconsistent with economic priors.
