Theme: Concerns Amongst Dsge Models

This topic post service gives an overview of my complaints (and perchance praise) nigh Dynamic Stochastic General Equilibrium (DSGE) models inwards economics. This post service volition move updated over time, every bit fabric is added.

Introduction

DSGE models accept larn the criterion macro modelling technique for mainstream economists, specially at primal banks. These models are fairly controversial, specially afterwards the financial crisis afterwards 2008-2009.

Unfortunately for the betoken of thought of writing nigh DSGE models, this is genuinely a really broad degree of mathematical models, which are non only used inwards macroeconomics. There are uses inwards overlapping generations models (which model consumer behaviour, but abstract out the residual of the economy), together with pricing of financial instruments. I am non genuinely interested inwards those uses of DSGE models, together with null I write applies to those forms of DSGE mathematical models; I am alone referring to the DSGE models applied to macro analysis.

Within the macroeconomic usages, in that place are 2 broad classes: Real Business Cycle (RBC) models, together with an offshoot, New Keynesian models. The RBC models came first, together with assumed completely flexible prices. The New Keynesian models added cost stickiness, which changes the cyclical behavior of the models considerably. Thousands of these models accept been churned out yesteryear academics together with primal banks, together with they oftentimes add together diverse "frictions" to arrange the behavior of the models.

Endowment Economy Example

In a serial of posts, I hash out a uncomplicated "endowment" economic scheme (an economic scheme where output happens without a labour/consumption trade-off). I explicate what the solution looks like, together with I hash out the problems amongst the authorities budget constraint. These problems cast uncertainty on the model solutions that are discussed inwards the literature.

• The Fiscal Theory of the Price Level together with Chartalism. How "fiscal backing" drives the value of the currency inwards a DSGE model, together with how this relates to Chartalism.
• Understanding the Fiscal Theory of the Price Level amongst Flexible Prices. 
• Monetary Frictions inwards DSGE Models. On how to add together constraints to pivot downward the initial cost bird inwards DSGE models.
• If r<g, DSGE Model Assumptions Break Down
• Non-transversality - [to move published]

Complaints About DSGE Assumptions

There are many who object to the assumptions based on microeconomic theory embedded inwards these models. The purpose of a representative household, which is assumed to alive forever together with rationally innovation out a consumption path for all time, is a item betoken of scorn.

Justification Of DSGE Models

The justifications given for the purpose of DSGE models include:

• Sensible reaction of embedded expectations to policy changes ("Lucas Critique").
• A unified, flexible framework for analysis.
• The purpose of math, instead of literary exposition, (hopefully) gives an objective mensurate of whether academic articles stand upward for novel noesis or not. (As an instance of the problems amongst non-mathematical economical theory, Austrian economic science has largely devolved into parsing texts written yesteryear dead economists.)
• Mathematical models tin forcefulness out move fitted (calibrated) to existent basis data, leading to quantitative predictions for scenario analysis.

I am sympathetic to these aims, although I am cautious nigh how good mathematical models tin forcefulness out predict cyclical behaviour. As such, I am non also concerned nigh many of the complaints nigh unopen to of the assumptions based on microeconomics.

These models accept a large issue of costless parameters. Since an interplanetary space issue of nonlinear models tin forcefulness out accept the same linear approximation ("linearisation"), the calibration techniques could conceivably seat the right linearisation, fifty-fifty if the nonlinear model they purpose is incorrect. This way that scenario analysis output would move correct, fifty-fifty if they accept the wrong nonlinear model.

External References:

(This is nether construction.)

• Sebastien Dullien - The New Consensus from a Traditional Keynesian together with Post-Keynesian Perspective. This article discusses a diverseness of problems amongst DSGE models. (Some were problems that I had noted inwards my ain weblog articles earlier I was aware of this reference.)

 

Complaint: DSGE Models Are Mathematically Or Economically Incoherent

DSGE models, every bit currently described inwards the literature, appear to accept problems amongst the mathematics and/or macroeconomic dynamics.

Posts:

• The purpose of the Representative Household way that solutions cannot deviate from the "full employment" equilibrium, if the optimisation is solved correctly. This supposition also makes the models unable to model authorities debt dynamics. 
• Formal mathematical proof of the previous betoken (draft article).
• The inter-temporal authorities budget constraint does non apply to real-world economies. There is an embedded supposition that the term premium is null (which I accept non seen noted inwards the literature). I give a counter-example that shows the pricing mistake may move arbitrarily large.
• Linearisation breaks the stock-flow consistency of the model (noted here).
• The supposition that the Net Present Value of authorities debt is null at infinity appears problematic. One job is that the macro accounting does non allow the representative solid to decide the bird of authorities debt. 
• Most of these models accept essentially a unmarried consumer proficient (or an uncountably interplanetary space issue of goods that are integrated out into a unmarried good). Models amongst alone a unmarried consumer proficient accept inherent problems modelling cyclical dynamics.

Complaint: DSGE Models Cannot Be Properly Fitted To Data

If DSGE models cannot move fitted correctly to the information ("calibrated" inwards economist-speak; "identified" to command systems engineers), the empirical arguments inwards their defense forcefulness disappear.

• A poor specification of financial policy inside many DSGE models way that their agree to information volition move systematically incorrect. The stabilising upshot of the welfare state's "automatic stabilisers" (passive financial policy) volition move attributed to other factors. It may move possible to modify the model to handgrip this, but the modified version volition come across "Ricardian Equivalence" (which I argued inwards a higher house is incoherent).
• It is non clear to me that the linearisation could move correctly fitted from observed economical data, fifty-fifty if the nonlinear model was correct. (Post to move written.)

Other Complaints

• If DSGE models are state-of-the-art, how come upward nobody inwards the someone sector uses them? (My comments on a betoken raised yesteryear others.)

(c) Brian Romanchuk 2013