In this paper we develop a Dynamic Stochastic General Equilibrium (DSGE) model for an open economy, and estimate it on euro area data using Bayesian estimation techniques.

Abstract. Bayesian priors are often used to restrain the otherwise highly over-parametrized vector autoregressive (VAR) models. The currently available Bayesian VAR methodology does not allow the user to specify prior beliefs about the unconditional mean, or steady state, of the system. This is unfortunate as the steady state is something that economists usually claim to know relatively well. This paper develops easily implemented methods for analyzing both stationary and cointegrated VARs, in reduced or structural form, with an informative prior on the steady state. We document that prior information on the steady state leads to substantial gains in forecasting accuracy on Swedish macro data. A second example illustrates the use of informative steady state priors in a cointegration model of the consumption-wealth relationship in the U.S.