Would DSGE Models Have Predicted the Great Recession in Austria?

Abstract

Dynamic stochastic general equilibrium (DSGE) models are the common workhorse of modern macroeconomic theory. Whereas story-telling and policy analysis were in the forefront of applications since its inception, the forecasting perspective of DSGE models is only recently topical. In this study, we perform a post-mortem analysis of the predictive power of DSGE models in the case of Austria’s Great Recession in 2009. For this purpose, eight DSGE models with different characteristics (small and large models; closed and open economy models; one and two-country models) were used. The initial hypothesis was that DSGE models are inferior in ex-ante forecasting a crisis. Surprisingly however, it turned out that not all but those models which implemented features of the causes of the global financial crisis (like financial frictions or interbank credit flows) could not only detect the turning point of the Austrian business cycle early in 2008 but they also succeeded in forecasting the following severe recession in 2009. In comparison, non-DSGE methods like the ex-ante forecast with the Global Economic (Macro) Model of Oxford Economics and WIFO’s expert forecasts performed comparable or better than most DSGE models in the crisis.