Macro Wars: Lavoie Article

Marc Lavoie has an splendid contribution to the recent reappearance of the "macro wars": "Rethinking Macroeconomic Theory Before the Next Crisis." I only desire to greenback that he is perhaps also academically reserved alongside regards to some of the claims justifying DSGE macro.

In the article, Lavoie discusses how the mainstream wishes to justify Dynamic Stochastic General Equilibrium (DSGE ) modelling on the footing that they piece of occupation good during an expansion. He writes:

The fundamental line of piece of occupation of defence forcefulness of orthodox economists is that the criticisms of orthodox macroeconomic theory are misdirected because, equally set forth yesteryear Thomas Sargent, its models ‘were designed to depict aggregate economical fluctuations during normal times … non during fiscal crises together with marketplace breakdowns’ (Rolnick, 2010). It is claimed that the top dog tool of fundamental bankers, the DSGE model, was doing real good equally long equally the American or European economies were moving along the lines of the Great Moderation. There seems to endure a consensus nigh the express arrive at of application of DSGE models. Charles Goodhart (2009, p. 352) writes that these models ‘were, yesteryear construction, fair conditions models only’.  [... deleted: Bernanke comments - BR] Blanchard (2014, p. 29), has also claimed that everyone knew that these models were useless when the conditions of the Great Moderation did non hold: ‘we all knew that at that topographic point were “dark corners” – situations inwards which the economic scheme could badly malfunction. But nosotros thought nosotros were far away from those corners, together with could for the most component ignore them’.[4] Blanchard (2014) soundless believed together with so that alongside improved models the economic scheme volition rest away from what he calls ‘the night corners’, where mainstream models tin give notice render no light. But this sounds similar wishful thinking. There is a bespeak for theories or models that accept these night corners equally genuine components or probable possibilities.

Marc Lavoie is plainly non a fan of DSGE models. However, he writes inwards a proper, polite, together with scholarly manner, together with so a casual reader could come upward away alongside also charitable a thought of DSGE macro. The thought that classical economic science describes "normal times," together with that Keynesian economic science only describes a downturn was a criterion means of reducing the importance of Keynes' contribution to the creation of macroeconomics. One could mistakenly extrapolate that interpretation equally applying to DSGE macro (since it is a direct descendant of classical macro).

In reality:

• DSGE macros are alone useless inwards describing a downturn.
• DSGE macros underperform drawing immediately lines though information during an expansion.

In other words, sticking lines through fourth dimension series [*] -- a generalisation of technical analysis used inwards fiscal markets -- dominates DSGE macro. The advantages of sticking immediately lines through information are:

• Very few people are foolish plenty to believe that nosotros tin give notice practice immediately line of piece of occupation extrapolation of economical fourth dimension series forever. Extrapolating DSGE macro predictions? Not so much.
• You practice non bespeak to pretend to sympathise stochastic calculus inwards club to stick a immediately line of piece of occupation through data.
• The odds that soul tin give notice set a immediately line of piece of occupation through information properly are a lot higher than getting them to run all of the statistical mumbo jumbo needed to crank out a DSGE model.
• We volition non receive got the province of affairs of trained academics debating what immediately lines "really mean." (See below.)

(As an illustration of debating what DSGE models "really mean," a proficient recent illustration is "Cheshire Cats together with New Keynesian Central Banks" yesteryear Professor Nick Rowe. That article is probable to endure the dependent land of some other rant -- I remember I handgrip alongside the DSGE orthodoxy inwards their interpretation. In whatever event, I only desire to greenback that inwards improver to Professor Rowe, Professor Brad DeLong agrees that the criterion interpretation of DSGE models brand no sense.)

Concluding Remarks

There is no economical authorities inwards which the usage of DSGE modelling methodology makes sense.

Appendix: DSGE Models are Nonlinear -- Yeah, Whatever

Some DSGE model purists mightiness object to my contestation that representative agent DSGE models are dominated yesteryear linear regressions, on the footing that the models are nonlinear (and thus non a subset of linear models).

This objection relies upon taking the ridiculous claims of DSGE authors at human face upward value. Sure, they write downwardly actually cool nonlinear models that aspect similar they belong on a blackboard on a Far Side cartoon. The reality is that those nonlinear models are only a bait-and-switch used to brand the models aspect less foolish than they actually are. There is no gamble whatsoever of solving the nonlinear system, together with so the authors pretend that they tin give notice linearise them. All of the statistical techniques are applied to the linear system, together with so that is the only version of the model which matters.

Footnote:

[*] More generally, nosotros bespeak to develop a regression model to generate our "straight line" model. Influenza A virus subtype H5N1 regression model involves mucking around alongside arbitrary linear models, inwards club to gibe observed data. Since the laid upward of linearised DSGE models is a subset of all possible linear models, the Definition of "subset" tells us that nosotros should hold off that a DSGE model volition receive got a worse "fit" (however nosotros define "fit") than an arbitrary linear model; at best, it tin give notice only tie.

(c) Brian Romanchuk 2016