Home > New vs. Old Paradigm > Microfounded DSGE models — a total waste of time!

Microfounded DSGE models — a total waste of time!

from Lars Syll

In 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.”

  1. Ken Zimmerman
    October 21, 2014 at 5:33 pm

    DSGE models continue to be “go to” tools for all the reasons you mention. Plus, let’s face it, it’s fun to play with models. Any 30something will tell you that. And let’s also face it that where else is there a tool, a theory, an equation that gives a precise and clear answer when questioned, even if it is stupid, irrelevant, and useless. There is something to be said for just answering the damn questions people are asking.

  2. October 22, 2014 at 9:08 pm

    Throwing soap bubbles at time wasters
    Comment on ‘Microfounded DSGE models — a total waste of time!’

    One defect is a bad thing, but countless defects are a good thing. This keeps the critics busy, the discussion lively, and the outcome forever inconclusive. Accordingly, Hahn was very happy with the critics of the neoclassical research program.

    “The enemies, on the other hand, have proved curiously ineffective and they have very often aimed their arrows at the wrong targets.” (Hahn, 1980, p. 127)

    He even warned his colleagues of exuberance.

    “For as I said at the outset, the citadel is not at all secure and the fact that it is safe from a bombardment of soap bubbles does not mean that it is safe.” (Hahn, 1984, p. 78)

    When homo oeconomicus was young and a simpleminded utility maximizer people laughed at him because of his unrealism. Poincaré, to be sure, choose his words.

    “Walras approached Poincaré for his approval. … But Poincaré was devoutly committed to applied mathematics and did not fail to notice that utility is a nonmeasurable magnitude. … He also wondered about the premises of Walras’s mathematics: It might be reasonable, as a first approximation, to regard men as completely self-interested, but the assumption of perfect foreknowledge ‘perhaps requires a certain reserve’.” (Porter, 1994, p. 154)

    What happened in the second approximation? Has nonsense been reduced since Walras? It has been multiplied by making it rigorous. This is what we actually have: ‘an infinitely lived intertemporally optimizing representative household/consumer/producer, agents with homothetic and identical preferences, etc.’ In the early days homo oeconomicus had only perfect foresight, now he has also eternal youth. Scientific progress is something different.

    “The last thirty years seem to this observer to have been downhill almost all the way. So much of the literature … I see as silly beyond all expectation and unscholarly beyond all endurance.” (Leijonhufvud, 1998, p. 234)

    Why have critics been so ineffective? Because they focus always on the most obvious weak link of the chain but do not understand the logic of the chain. J. S. Mill did, and he clearly stated the key question.

    “What are the propositions which may reasonably be received without proof? That there must be some such propositions all are agreed, since there cannot be an infinite series of proof, a chain suspended from nothing. But to determine what these propositions are, is the opus magnum of the more recondite mental philosophy.” (Mill, 2006, p. 746)

    The fault of an approach lies always in the first element of the chain: in the axiomatic foundations. Keynes knew this.

    “For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises.” (Keynes, 1973, p. xxi)

    An effective critique does not waste time with the plain unrealism of some heroic assumption in the middle of the chain. An effective critique finds a new hook to hang an impeccable logical chain on, that is, an effective critique changes the axiomatic foundations (2014a; 2014b).

    After more than a century, it is pointless to repeat Poincarés critique of homo oeconomicus. Homo emotionalis or homo sociologicus are not the solution. Simply take ALL behavioral assumptions out of the formal foundations of economic theory. Second-guessing the agents is a waste of time.

    “… there has been no progress in developing laws of human behavior for the last twenty-five hundred years.” (Hausman, 1992, p. 320), (Rosenberg, 1980, pp. 2-3)

    Egmont Kakarot-Handtke

    Hahn, F. H. (1980). General Equilibrium Theory. Public Interest. Special Issue:
    The Crisis in Economic Theory, pages 123–138.

    Hahn, F. H. (1984). Equilibrium and Macroeconomics. Cambridge, MA: MIT

    Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge:
    Cambridge University Press.

    Kakarot-Handtke, E. (2014a). Objective Principles of Economics. SSRN Working
    Paper Series, 2418851: 1–19. URL http://papers.ssrn.com/sol3/papers.cfm?

    Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics:
    Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

    Keynes, J. M. (1973). The General Theory of Employment Interest and Money.
    The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke:
    Macmillan. (1936).

    Leijonhufvud, A. (1998). Discussion: Involuntary Unemployment One More
    Time. In R. E. Backhouse, D. M. Hausman, U. Mäki, and A. Salanti (Eds.),
    Economics and Methodology. Crossing Boundaries., pages 225–235. Houndmills,
    Basingstoke, London: Palgrave.

    Mill, J. S. (2006). Principles of Political Economy With Some of Their Applications
    to Social Philosophy, volume 3, Books III-V of Collected Works of John Stuart
    Mill. Indianapolis, IN: Liberty Fund. URL http://www.econlib.org/library/Mill/
    mlP.html. (1866).

    Porter, T. M. (1994). Rigor and Practicality: Rival Ideals of Quantification in
    Nineteenth-Century Economics. In P. Mirowski (Ed.), Natural Images in Economic
    Thought, pages 128–170. Cambridge: Cambridge University Press.

    Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford:

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