A Method for Taking Models to the Data

This paper develops a method for combining the power of a dynamic, stochastic, general equilibrium model with the flexibility of a vector auto-regressive time-series model to obtain a hybrid that can be taken directly to the data. It estimates this hybrid model via maximum likelihood and uses the results to address a number of issues concerning the ability of a prototypical real business cycle model to explain movements in aggregate output and employment in the postwar US economy, the stability of the real business cycle model’s structural parameters, and the performance of the hybrid mode’s out-of sample forecasts.