An Estimated DSGE Model of the Indian Economy

Abstract This article studies business cycle dynamics in the Indian economy using a new Keynesian dynamic stochastic general equilibrium (DSGE) framework. This is one of the first attempts to estimate a DSGE model for the Indian economy. The policy relevance of conducting such an exercise is without question: High growth in India since 1991 has been accompanied by significant trade and financial liberalization. Policy makers face significant trade-offs in ensuring price and financial stability in devising monetary conditions in response to external shocks. Therefore, understanding the mechanisms that contribute to the amplification and propagation of shocks requires careful investigation. The article develops a closed-economy DSGE model of the Indian economy and estimates it by Bayesian maximum likelihood methods using Dynare software. The article also adds newer features to the model sequentially, giving a clear indication of how such models may be built and ultimately used by researchers.