‘New Keynesian’ macroeconomics — worse than useless

24 Jun, 2021 at 17:26 | Posted in Economics | 4 Comments

Mainstream macroeconomics can only progress if it gets rid of the DSGE albatross around its neck. It is better to do it now than to wait for another 20 years because the question is not whether but when DSGE modeling will be discarded. DSGE modeling is a story of a death foretold …

New Keynesian' macroeconomics | LARS P. SYLLGetting rid of DSGE models is critical because the hegemonic DSGE program is crowding out alternative macro methodologies that do work … DSGE practitioners, who with a mixture of bluff and bluster act as gatekeeper, judge, jury, and executioner in all macroeconomic matters, are a block on the road to progress. The roadblock has to be removed. The failed and failing DSGE models have to go if mainstream macroeconomics wants to become a force for the common good again.

Servaas Storm

Servaas’ article is a marvellous final take down of the ridiculous aspirations of New-Classical-New-Keynesian macroeconomic modelling. DSGE models are worse than useless — and still, mainstream economists seem to be überimpressed 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.

‘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 decisive empirical evidence has been presented. DSGE models are nothing but a joke.

keynes-right-and-wrong

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 the one and only 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.

As David Hand tells us — building models based on questionable ontological or epistemological assumptions may be fine in mathematics and religion, but it certainly is not science:

impIf you want absolute truth then you must look to pure mathematics or religion, but certainly not to science … Science is all about possibilities. We propose theories, conjectures, hypotheses and explanations. We collect evidence and data, and we test the theories against this new evidence … It’s the very essence of science that its conclusions can change, that is, that its truths are not absolute. The intrinsic good sense of this is contained within the remark reportedly made by the eminent economist John Maynard Keynes, responding to the criticism that he had changed his position on monetary policy during the 1930s Depression: “When the facts change, I change my mind. What do you do, sir?”

DSGE models belong — as Servaas suggests — in the Museum of Implausible Economic Models. Making adjustments to Ptolemaic epicycles or trying to amend and elaborate on flat earth theories and models is both stupid and tragic. It’s a waste of time and effort. As we all know there are better alternatives.

4 Comments

  1. The author fails to reveal to readers what DSGE stands for. Or have I missed something?

    • Heh. Best do a web search, or check Wikipedia. DSGE stands for Dynamic Stochastic General Equilibrium. It’s a big mathematical framework for constructing macroeconomic models, and it’s been used heavily by a large portion of economists for the last half-century or more. It’s received negative attention from many economists (e.g. those called “heterodox”) because the assumptions that make these models consistent and mathematically tractable don’t seem realistic. There’s a mountain of reading to do. Brian Romanchuck is doing a survey of selected DSGE papers to analyze what makes them tick. His articles might simplify the work.

      • Mightn’t financial firms explicitly and voluntarily make Profit and Loss their utility function, i.e traders consciously try to act rationally to maximize dollar profit, and when you properly scale the size of the financial sector relative to other sectors as some recent Bank for International Settlements DSGE papers do, you just drown out the irrationality of real economic microfoundations?

  2. [The linked article says: ] “pithy attempts to incorporate money in DSGE models are bound to fail as long as DSGE practitioners continue to gloss over the role of money-creating commercial banks and remain wedded to models of a market for loanable funds provided by savers.”
    .
    Doesn’t the DSGE model in https://www.bis.org/publ/work890.htm include a financial sector, calibrated to be so large (based on BIS data) that it dwarfs the other sectors and allows the authors to dispel such economic myths as Triffin’s dilemma?
    .
    Isn’t it fun to use a mainstream model to disprove mainstream assumptions such as Simon Wren-Lewis’s “gravity model of trade”?
    .
    “Proving things ‘rigorously’ in DSGE models is at most a starting-point for doing an interesting and relevant economic analysis.”
    .
    Isn’t the analysis in https://www.bis.org/publ/work890.htm interesting and relevant, because when you include a properly scaled financial sector, you find that trade in real goods is almost a rounding error compared to international capital flows?


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