Dear all:
I am working with a DSGE model, and I try to simulate the different reactions of the economy to permanent shocks and temporary shocks, but I’m not sure the setting is right or not. Take the technology shock for example, At=rho*A(t-1)+et, if I simulate the permanent shock , I set the persistence parameter rho=1, if I simulate the temporary shock, I set 0<rho<1, is this setting right or not? Or there are other differences?
Looking forward to your reply!
A permanent shock is a shock that will shift the steady state. So, depending on the size of the shock, it may not be very accurate to use a local approximation to solve a model (since the approximation is done around a steady state). It will be a problem if the steady state ratios that appear in the approximated model are affected by the (permanent) shock. I would use instead a perfect foresight model. You will find in the reference manual how to simulate permanent shocks in deterministic models.
Your approach is correct but you are potentially missing the effects of the permanent shock on elasticities (note that the temporary shock cannot affect these elasticities, or steady state ratios). If you want to analyse the full effect of permanent vs. temporary shock, a perfect foresight model seems better suited. But I do not know what you are looking for here…
Best,
Stéphane.
See also