An Estimated DSGE Model of the Indian Economy.

An Estimated DSGE Model of the Indian

Economy *

Vasco Gabriel           Paul Levine

University of Surrey University of Surrey

Joseph Pearlman

London Metropolitan University

Bo Yang

University of Surrey and London Metropolitan University

August 2010

Abstract

We develop a closed-economy DSGE model of the Indian economy and estimate it
by Bayesian Maximum Likelihood methods using Dynare. We build up in stages to
a model with a number of features important for emerging economies in general and
the Indian economy in particular: a large proportion of credit-constrained consumers,
a financial accelerator facing domestic firms seeking to finance their investment, and
an informal sector. The simulation properties of the estimated model are examined
under a generalized inflation targeting Taylor-type interest rate rule with forward and
backward-looking components. We find that, in terms of model posterior probabilities
and standard moments criteria, inclusion of the above financial frictions and an infor-
mal sector significantly improves the model fit.

JEL Classification: E52, E37, E58

Keywords: Indian economy, DSGE model, Bayesian estimation, monetary interest
rate rules, financial frictions.

* We acknowledge financial support for this research from the Foreign Commonwealth Office as a con-
tribution to the project “Building Capacity and Consensus for Monetary and Financial Reform” led by
the National Institute for Public Finance Policy (NIPFP). The paper has benefited from excellent research
assistance provided by Rudrani Bhattachrya and Radhika Pandey, NIPFP.

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