Measurement with some theory: using sign restrictions to evaluate business cycle models ∗

Abstract

We propose a method to evaluate business cycle models which does not require knowledge of the DGP and is robust to the time series specification of the aggregate decision rules. We derive robust restrictions in a class of models; use some of them to identify structural shocks and others to evaluate the model. The approach has good size and excellent power properties even in small samples. The median of the distribution of the responses is a good estimator of the true responses. We examine the dynamics of hours in response to technology shocks and of consumption in response to goverment expenditure shocks.

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