Measurement with Some Theory: a New Approach to Evaluate Business Cycle Models (with appendices)

• Authors: Fabio Canova and Matthias Paustian
• BSE Working Paper: 511 | March 2026
• Keywords: sign restrictions, shock identification, model validation, misspecification
• JEL codes: E32, C32

We propose a method to evaluate cyclical models which does not require knowledge of the DGP and the exact specification of the aggregate decision rules. We derive robust restrictions in a class of models; use some to identify structural shocks in the data and others to evaluate the class or contrast sub-models. The approach has good properties, even in small samples and when the likelihood is misspecified. We showhow to sort out the relevance of a certain friction (the presence of rule-of-thumb consumers) in a standard class of models.