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


  1. Great pic of the DSGE “model”. 😉

  2. 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.

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