Evaluating Historical Episodes using Shock Decompositions in the DSGE Model

IMF Working Papers, March 7, 2025

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Presents alternative methods for calculating and interpreting the influence of exogenous shocks on historical episodes within the context of DSGE models.
Shows analytically why different methods for calculating shock decompositions can generate conflicting interpretations of the same historical episodes.
Illustrates arguments using an extended version of Drautzburg and Uhlig’s (2015) model of the U.S. economy.
Focus periods analyzed: 1964–1966, 1979–1987, 2006–2009, 2016–2020 and 2020–2023.

Different shock-decomposition methods can produce conflicting interpretations for the same historical episode.
The source of conflicts is demonstrated analytically within the DSGE-model framework.
Emphasis on the role of initial conditions and their representation relative to balanced growth path in interpreting decompositions.

Model used: extended version of Drautzburg and Uhlig’s (2015) model of the U.S. economy.
Historical episodes investigated:
- 1964–1966
- 1979–1987
- 2006–2009
- 2016–2020
- 2020–2023

The best method for analyzing particular episodes:
- isolates the influence of the shocks during the period under consideration, and
- sets initial conditions that represent the system’s distance from balanced growth path at the beginning of the episode.

Subjects: Central bank policy rate, Expenditure, Financial institutions, Financial services, National accounts, Private investment, Public investment spending, Sovereign bonds
Keywords: Central bank policy rate, copyright page, decomposition method, differencing method, DSGE model, Financial Frictions, Fiscal Policy, Global, influence of the shock, monetary policy shock, Private investment, Public investment spending, Shock Decomposition, Sovereign bonds

IMF Working Paper No. 2025/051