DSGE models — a report from the ‘scientific battlefield’

23 March, 2016 at 11:04 | Posted in Economics | 1 Comment

teamIn conclusion, one can say that the sympathy that some of the traditional and Post-Keynesian authors show towards DSGE models is rather hard to understand. Even before the recent financial and economic crisis put some weaknesses of the model – such as the impossibility of generating asset price bubbles or the lack of inclusion of financial sector issues – into the spotlight and brought them even to the attention of mainstream media, the models’ inner working were highly questionable from the very beginning. 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 most young academic macroeconomists want to work with DSGE models. After reading Dullien’s article, 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 this job.’

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  1. Of course DSGE is of little interest to someone who is genuinely interested in truly understanding and finding a solution to economic problems like poverty and unemployment with a view to dealing with social problems. It is not stuff for people with genuinely enquiring minds. But it keeps the current power arrangements and elites in place and creates a barrier to entry. It is also about identity – all the Greek letters make the subject look ‘sophisticated’ to the uninformed. Basically if you are mathematician and physician – but not good enough to work in those professions, your expressive skills are also largely limited to these areas, you land want to work in abstraction and not really get out on to the field, and secure an income, even a ‘nobel’ prize, economics is for you.


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