Measurement with some theory: a new approach to evaluate business cycle models

Abstract

We propose a method to evaluate cyclical models which does not require knowledge of the DGP and the exact empirical speci…cation of the aggregate decision rules. We derive robust restrictions in a class of models; use some to identify structural shocks and others to evaluate the model or contrast sub-models. The approach has good size and excellent power properties, even in small samples. We show how to examine the validity of a class of models, sort out the relevance of certain frictions, evaluate the importance of an added feature, and indirectly estimate structural parameters.

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