<p><strong>Yes, there are DSGE models that can be used for forecasting.</strong></p>
<p>These models typically have a particular kind of steady-state, which is, more precisely, called <em>balanced growth path</em> <a href="https://en.wikipedia.org/wiki/Balanced-growth_equilibrium" rel="nofollow noreferrer">(BGP)</a>. On the BGP (in the absence of shocks), key indicators growth at the same constant rate. For example, GDP, household consumption, investment all grow at 2% a year. This is consistent with constant steady-state ratios of the indicators over GDP, for example <span class="math-container">$\frac{K}{Y}$</span> and <span class="math-container">$\frac{C}{Y}$</span> would be constant, while indicators grow at the same rate.</p>
<p>The rate itself is often built in as an assumption, based on economic priors and analysis done outside of the DSGE model (for example estimates of labor-productivity growth). Because of this fact, forecast of equilibrium growths are not just boring, but not really forecasts. However, an economy is hardly ever on its balanced growth path, so the strength of these models is in describing the dynamics back towards equilibrium, for example after a shock to global oil prices. Immediately after the shock hits, investment will typically fall at a faster rate than GDP, and then grow faster after the impact has bottomed out.</p>
<p>Note that these models need to be related to actual data via estimation, often using the Kalman Filter to identify unobservable variables, such as the output gap, and shocks (such as a technology shock).</p>
<p>To see how data can be related to model variables, consider the measurement equation (assuming the use of a Kalman filter). <span class="math-container">$Y$</span> is actual GDP in quarterly frequency, <span class="math-container">$\hat{y_t}$</span> is the deviation of output from its trend level at time <span class="math-container">$t$</span>, and 2% is the assumed annual growth rate. Then this can be fed into the model as
<span class="math-container">$$
\log Y_t - \log Y_{t-1} - 0.005 = \hat{y}_t - \hat{y}_{t-1}
$$</span>
This means in particular that the model solution can be translated back into numbers that are consistent with actual data and hence <em>can be used for forecasting</em>.</p>
<p><em>References:</em> For an overall good and detailed example, see the <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp944.pdf" rel="nofollow noreferrer">ECB's New Area Wide Model</a>. It includes a section on model dynamics (4), and one on how assumptions are built into the model (3.2 &amp; 3.3). The references in that paper are also worth checking out. For an even more modern version, see their new <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2200.en.pdf" rel="nofollow noreferrer">model</a>, which includes many more financial market dynamics.</p>

CC BY-SA 4.0
2021-08-21T16:23:30.570Z
Awesome, thanks for the detail and links!
Mich55
CC BY-SA 4.0
2021-08-21T17:18:18.550Z
@Mich55 in addition to the references in the +1 answer above I would also recommend you to have a look at Wickens Macroeconomic Theory a dynamic stochastic equilibrium approach - it’s quite comprehensive text and if I remember correctly it has an online companion with some example code
1muflon1
CC BY-SA 4.0
2021-08-21T16:07:55.437Z
2021-08-21T16:07:55.437Z
BrsG
<p>The DSGEs I've seen have steady-states, and mean-zero shocks.</p>
<p><strong>Can these predict growth in GDP / capital etc?</strong></p>
<p>Is this possible despite them being <em>equilibrium</em> models, or do you have to completely change your approach and switch to a Solow-Swan-type model to predict GDP growth?</p>

<economic-growth><dsge><solow>
Economic growth in a DSGE model, despite mean-zero shocks
Mich55
# Economic growth in a DSGE model, despite mean-zero shocks

(Asked by: username_0 on 2021-08-21)

The DSGEs I've seen have steady-states, and mean-zero shocks.

**Can these predict growth in GDP / capital etc?**

Is this possible despite them being *equilibrium* models, or do you have to completely change your approach and switch to a Solow-Swan-type model to predict GDP growth?

**Tags:** economic-growth, dsge, solow


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## 1 answers

### Answer by username_1 on 2021-08-21. Score: 3 | Accepted answer

**Yes, there are DSGE models that can be used for forecasting.**

These models typically have a particular kind of steady-state, which is, more precisely, called *balanced growth path* [(BGP)](https://en.wikipedia.org/wiki/Balanced-growth_equilibrium). On the BGP (in the absence of shocks), key indicators growth at the same constant rate. For example, GDP, household consumption, investment all grow at 2% a year. This is consistent with constant steady-state ratios of the indicators over GDP, for example $\frac{K}{Y}$ and $\frac{C}{Y}$ would be constant, while indicators grow at the same rate.

The rate itself is often built in as an assumption, based on economic priors and analysis done outside of the DSGE model (for example estimates of labor-productivity growth). Because of this fact, forecast of equilibrium growths are not just boring, but not really forecasts. However, an economy is hardly ever on its balanced growth path, so the strength of these models is in describing the dynamics back towards equilibrium, for example after a shock to global oil prices. Immediately after the shock hits, investment will typically fall at a faster rate than GDP, and then grow faster after the impact has bottomed out.

Note that these models need to be related to actual data via estimation, often using the Kalman Filter to identify unobservable variables, such as the output gap, and shocks (such as a technology shock).

To see how data can be related to model variables, consider the measurement equation (assuming the use of a Kalman filter). $Y$ is actual GDP in quarterly frequency, $\hat{y\_t}$ is the deviation of output from its trend level at time $t$, and 2% is the assumed annual growth rate. Then this can be fed into the model as
$$
\log Y\_t - \log Y\_{t-1} - 0.005 = \hat{y}\_t - \hat{y}\_{t-1}
$$
This means in particular that the model solution can be translated back into numbers that are consistent with actual data and hence *can be used for forecasting*.

*References:* For an overall good and detailed example, see the [ECB's New Area Wide Model](https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp944.pdf). It includes a section on model dynamics (4), and one on how assumptions are built into the model (3.2 & 3.3). The references in that paper are also worth checking out. For an even more modern version, see their new [model](https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2200.en.pdf), which includes many more financial market dynamics.

> **Comments:**
> **username_0**: Awesome, thanks for the detail and links!  
> **username_2**: @username_0 in addition to the references in the +1 answer above I would also recommend you to have a look at Wickens Macroeconomic Theory a dynamic stochastic equilibrium approach - it’s quite comprehensive text and if I remember correctly it has an online companion with some example code  

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