Dynamic Stochastic General Equilibrium (DSGE) Modelling :Theory And Practice

In recent years DSGE (dynamic stochastic general equilibrium) models have come to play an increasing role in central banks, as an aid in the formulation of monetary policy (and increasingly after the global crisis, for maintaining financial stability). DSGE models, compared to other widely prevalent econometric models (such as VAR, or large-scale econometric models) are less a-theoretic and with secure microfoundations based on the optimizing behavior of rational economic agents. Apart from being “structural”, the models bring out the key role of expectations and (being of a general equilibrium nature ) can help the policy maker by explicitly projecting the macro-economic scenarios in response to various contemplated policy outcomes.