DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM (DSGE)
MODEL
The General Equilibrium model of the economy enables to analyze the
real macroeconomic situation and ensures accuracy and adequacy of the
decisions taken for effective macroeconomic management. Construction
of such a model will result in analysis of sensitivity of the economy to
internal and external shocks, as well as effects of the monetary and fiscal
decisions in a given timeframe.
In contrast to other macro models, because the Dynamic Stochastic General
Equilibrium (DSGE) model includes consideration of decisions of
micro-level agents in macro-level decisions, the effect of the decisions of
economic agents on macroeconomic indicators was assessed via the
following models:
1. The utility function of households:

 c j  h~H
t
Ut    t
1


c

j
C
t

1 c
1 m
1
L
M M j 
 t lt j   t  t 
1  l
1   m  Pt 
l



where:
j - the index for households, j  0,1
i - the index for differentiated domestic and foreign products
U t j - instant profitability function of households at t time
Ct j - consumer index of households at t time
H t – past aggregate consumer index at t time
~
h – habit sustainability index
lt j - differentiated labor supply of households at t time
M t j - demand of households for nominal money at t time
Pt – general price index
 c – relative risk aversion coefficient or interperiod reverse of replacement elasticity
 l – reverse of work attempt elasticity against real salary
 m – reverse of demand for money elasticity against interest rate
taste shock
 tC
 tL - labor supply shock
 tM – money demand shock
2. Production function of the companies that produce final products:

Q  


C
t
1
C
C ,t
H 
1
C 1 
C
t
 1 C,t 
1
C
1

C
C
IM
C 1  
C 
 1 C IMt / Qt ; t IMt






C
C 1
where:
QtC – personal consumer commodities
H tC –domestic interim consumer commodities
IM tC – imported interim consumer commodities
C – replacement elasticity coefficient between domestic and imported interim consumer
commodities IM C – expenditures on adjustment of imported interim commodities in
production of consumer commodities
 C ,t –coefficient to express advantageability of domestic interim consumer commodities
The utility function employed in the model comprises consumption, labor
force and money supply; intermediate goods consumption function –
capital, technology and labor force; final product – indicators on
intermediate and import commodities. Production of raw materials is
exogenously incorporated to the model. In addition, government and
monetary institutions are also incorporated to the model. When making an
assessment, the monetary institution is assumed to pursue the fixed
exchange rate policy.
The DSGE model is both utilized for forecasting and economic analyses (i.e.
as a core model), and a supplementary modeling tool. Nominal and real
indicators incorporated in the model may effectively address the impact of
monetary policy shocks.
Major economic literature documents good performance of new Keynesian
models in forecasting when compared to Bayes VAR models. Theoretically,
the DSGE model is estimated via calibration and econometric technique. To
avoid some imperfections lingering in a transition economy, use of the
calibration technique when assessing the DSGE model on Azerbaijan
allowed additional opportunities.
To provide econometric evaluation, ML, Bayes, GMM and a number of
other econometric methods were utilized.