DSGE models — a total waste of time

17 May, 2024 at 11:32 | Posted in Economics | Comments Off on DSGE models — a total waste of time

While one can understand that some of the elements in DSGE models seem to appeal to Keynesians at first sight, after closer examination, these models are in fundamental contradiction to Post-Keynesian and even traditional Keynesian thinking. The DSGE model is a model in which output is determined in the labour market as in New Classical models and in which aggregate demand plays only a very secondary role, even in the short run.

In addition, given the fundamental philosophical problems presented for the use of DSGE models for policy simulation, namely the fact that a number of parameters used have completely implausible magnitudes and that the degree of freedom for different parameters is so large that DSGE models with fundamentally different parametrization (and therefore different policy conclusions) equally well produce time series which fit the real-world data, it is also very hard to understand why DSGE models have reached such a prominence in economic science in general.

Sebastian Dullien

Neither New Classical nor ‘New Keynesian’ microfounded DSGE macro models have helped us foresee, understand or craft solutions to the problems of today’s economies. But still, many young academic macroeconomists want to work with DSGE models. That certainly should be a very worrying confirmation of economics — at least from the point of view of realism and relevance — becoming more and more a waste of time. Why do these young bright guys waste their time and efforts? Besides aspirations of being published, I think maybe Frank Hahn gave the truest answer back in 2005 when interviewed on the occasion of his 80th birthday, he confessed that some economic assumptions didn’t really say anything about “what happens in the world,” but still had to be considered very good “because it allows us to get on with this job.”

Hahn’s answer reminds me of an episode when, thirty years ago, Phil Mirowski was invited to give a speech on themes from his book More Heat than Light at my economics department in Lund, Sweden. All the mainstream professors were there. Their theories were totally mangled and no one — absolutely no one — had anything to say even remotely reminiscent of a defence. Being at a nonplus, one of them, in total desperation, finally asked: “But what shall we do then?”

Yes indeed — what shall one do when the emperor has turned out to be naked?