Darshan Hiranandani : When to Use DSGE Models for Forecasting and How to Handle Structural Shifts

[jpfeifer]

As a first step, please see

When is it appropriate to use DSGE models for forecasting?

Forecasts in such cases will not be invalid, but rather may perform poorly relative to the actual data realizations. Fundamentally, forecasting with DSGE models assumes that the model solution is the data generating process. Whenever that assumption is invalid, the the forecasts will deviate from the data for other reasons than just unforeseen shocks. That may be because the model solution is linear but the DGP is not, because the model assumes no structural breaks but there are some in data, e…