Finance and Economics Discussion Series: Practical Tools for Policy Analysis in DSGE Models with Missing Channels

In this paper we analyze the propagation of shocks originating in sectors that are not present in a baseline dynamic stochastic general equilibrium (DSGE) model. Specifically, we proxy the missing sector through a small set of factors, that feed into the structural shocks of the DSGE model to create correlated disturbances. We estimate the factor structure by matching impulse responses of the augmented DSGE model to those generated by an auxiliary model. We apply this methodology to track the effects of oil shocks and housing demand shocks in models without energy and housing sectors.