DSGE models — false by construction

25 Apr, 2018 at 18:05 | Posted in Economics, Statistics & Econometrics | Comments Off on DSGE models — false by construction

Advances in mathematical tools and in economic theory rapidly changed the landscape. From the perspective of macroeconomics, the streamlined DSGE models of the 1980s begot much richer models in the 1990s. One remarkably successful extension was the introduction​ of nominal and real rigidities, i.e., the conception that agents cannot immediately adjust to changes in the economic environment. In particular, many of the new DSGE models focused on studying the consequences of limitations in how frequently or how easily agents can changes prices and wages (prices and wages are “sticky”). Since the spirit of these models seemed to capture the tradition of Keynesian economics, they quickly became known as New Keynesian DSGE models (Woodford, 2003) …

londonbridgefallingdown

One of the features of the New Macroeconometrics that the readers of this volume will find exciting is that the (overwhelming?) majority of it is done from an explicitly Bayesian perspective​ …

The Bayesian approach deals in a transparent way with misspecification and identification problems, which are pervasive in the estimation of DSGE models … After all, a DSGE model is a very stylized and simplified view of the economy that focuses only on the most important mechanisms at play. Hence, the model is false by construction​ and we need to keep this notion constantly in view …

Jesús Fernández-Villaverde et al.

Keep that “constantly in view.”

Hmm.

Seems some economists have a bad memory.

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