DSGE ​​models — worse than useless

8 August, 2017 at 18:04 | Posted in Economics | 1 Comment

The main point of this book is to serve as an antidote to the intellectual poison of the erroneous’veil of ignorance’ aphorism … Accordingly [it] rejects as erroneous the standard macroeconomic model, whose assumptions have been built into DSGE models.

ehntsAmong other conceptual absurdities, such as the assumption that economic actors consist of identical omniscient ‘rational agents’ all of whom have perfect information about prices and quantities everywhere in the global economy, DSGE models generally incorporate the erroneous ‘veil of barter’ notion and ignore the functioning of real monetary systems …

DSGE models represent the distilled essence of the past three decades of dominant macroeconomic theory. Yet they are, to put it bluntly, nonsense, There is only one representative agent — no meaningful discussion of debt can take place in such a theoretical frame. These models are worse than useless — they are misleading.

Dirk Ehnts is, of course, absolutely right. DSGE models are worse than useless — and still mainstream economists seem to be impressed by the ‘rigour’ brought to macroeconomics by New-Classical-New-Keynesian DSGE models and its rational expectations and microfoundations!

It is difficult to see why.

Take the rational expectations assumption. Rational expectations in the mainstream economists’ world imply that relevant distributions have to be time independent. This amounts to assuming that an economy is like a closed system with known stochastic probability distributions for all different events. In reality it is straining one’s beliefs to try to represent economies as outcomes of stochastic processes. An existing economy is a single realization tout court, and hardly conceivable as one realization out of an ensemble of economy-worlds since an economy can hardly be conceived as being completely replicated over time. It is — to say the least — very difficult to see any similarity between these modelling assumptions and the expectations of real persons. In the world of the rational expectations hypothesis we are never disappointed in any other way than as when we lose at the roulette wheels. But real life is not an urn or a roulette wheel. And that’s also the reason why allowing for cases where agents make ‘predictable errors’ in DSGE models doesn’t take us any closer to a relevant and realist depiction of actual economic decisions and behaviours. If we really want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make we have to replace the rational expectations hypothesis with more relevant and realistic assumptions concerning economic agents and their expectations than childish roulette and urn analogies.

‘Rigorous’ and ‘precise’ DSGE models cannot be considered anything else than unsubstantiated conjectures as long as they aren’t supported by evidence from outside the theory or model. To my knowledge no in any way decisive empirical evidence has been presented.

keynes-right-and-wrong

No matter how precise and rigorous the analysis, and no matter how hard one tries to cast the argument in modern mathematical form, they do not push economic science forwards one single millimetre if they do not stand the acid test of relevance to the target. No matter how clear, precise, rigorous or certain the inferences delivered inside these models are, they do not say anything about real world economies.

Proving things ‘rigorously’ in DSGE models is at most a starting-point for doing an interesting and relevant economic analysis. Forgetting to supply export warrants to the real world makes the analysis an empty exercise in formalism without real scientific value.

Mainstream economists think there is a gain from the DSGE style of modelling in its capacity to offer some kind of structure around which to organise discussions. To me, that sounds more like a religious theoretical-methodological dogma, where one paradigm rules in divine hegemony. That’s not progress. That’s the death of economics as a science.

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1 Comment

  1. DSGE is so remote and disconnected from any appreciation for the institutional mechanisms of the actual economy — either the function or dysfunction of those mechanisms — it is difficult to understand how anyone with the slightest interest in political economy could be persuaded to invest enormous effort in the intellectual project of constructing DSGE models. Yet, people do invest that effort, call themselves “economists” and are honored by the academy, assigned responsibility to teach an economics that knows nothing of the economy.
    .
    Persuading people who have been successful in pursuing this bizarre career path, people who have no interest or acquaintance with the actual economy, that they should develop an interest in how the economy works and in effective methods of investigating how the economy works — it does seem a challenging task.


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