Several prominent economists have argued that existing DSGE models cannot properly account for the evolution of key macroeconomic variables during and following the recent Great Recession. We challenge this argument by showing that a standard DSGE model with financial frictions available prior to the recent crisis successfully predicts a sharp contraction in economic activity along with a protracted but relatively modest decline in inflation, following the rise in financial stress in 2008Q4. The model does so even though inflation remains very dependent on the evolution of economic activity and of monetary policy.

JEL: C52, E31, E32, E37
Keywords: Bayesian Estimation, DSGE Models, Fundamental Inflation, Great Recession, Missing Disinflatione.