The core problem with DSGE models

18 Mar, 2015 at 17:37 | Posted in Economics | 2 Comments

[DSGE] models ‘force’ behavioral changes through adjustment mechanisms that operate in narrowly parameterized equilibrium spaces. So violations of key model assumptions are introduced economically ‘one by one’ …

fubar1-2This modeling convention … makes it virtually impossible to incorporate concerns that are central to heterodox economics: liquidity preference, power in finance, predatory behavior, illiquid asset markets, increasing inequality in income and wealth …

One possibly decisive structural change has yet to be — and perhaps cannot be — acknowledged through DSGE modeling: the fact that most nations in the global North are simultaneously pursuing austerity policies. It is obvious in trade theory that every nation in a global trading system cannot maintain a surplus on current account. But this obvious result, which is an implication of a regime in which nation after nation is pursuing austerity macroeconomic policies, cannot be expressed in a macroeconomics based on models that focus almost completely on intertemporal coordination, while ignoring point-in-time structural interconnections.

Gary Dymski

2 Comments

  1. In Martin Schroder’s 2013 “Integrating Varieties of Capitalism and Welfare State Research,” he points out that the Social Democratic countries, which are Nordic, are distinguished by a national coordination of production and welfare in ways that enforce a commitment to social equality. This does not mean that they run a high deficit or fail to balance their budgets, at all. But, there is a focus on equality which does not run into the deficit problems of the EU southern nations, nor the high tension over welfare expenditures in the US.

  2. Great pic of the DSGE “model”. 😉


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