A Bayesian approach to dynamic macroeconomics

We propose and implement a coherent statistical framework for combining theoretical and empirical models of macroeconomic activity. The framework is Bayesian, and enables the formal yet probabilistic incorporation of uncertainty regarding the parameterization of theoretical models. The approach is illustrated using a neoclassical business-cycle model that builds on the Greenwood et al. (1988, American Economic Review 78, 402–417) variable-utilization framework to study out-of-sample forecasting of output and investment. The forecasts so produced are comparable with those from a Bayesian vector autoregression.