‘DSGE’ macro models criticism: a limited round-up. Part 1. Money.
On this site, we’ve occasionally criticized neoclassical ‘DSGE’ (Dynamic Stochastic General Equilibrium) macro models. Time for a round-up (comments welcome). This succinct round-up will not be an extensive discussion but will only provide some resources and, important, pay explicit attention to economic statistics which, as a rule, are conceptually much more consistent with Post-Keynesian and sometimes classical and Austrian economics than with neoclassical ‘macro’. I’ll use the next taxonomy to do this:
* Land, Labour, Capital
* Interest and portfolio’s
* Market fundamentalism
Update: because of comments the next items are added:
* The intertemporral government budget constraint
Money. The way Eurozone statisticians estimate ‘money’ can be found in this older 1999 ECB manual, which is consistent with the way Japanese, British or USA statisticians estimate ‘money’ as well as with newer manuals, which however do take recent institutional changes into account (shadow banking). There is an internationally and historical consistent approach to estimating money – a hallmark of science. Money is seen as totally endogenous to the economic system (including asset transactions and mortgage credit). The banking system is essentially described as one big bank with the central bank at its core and with so called private banks as branches of the central bank. This system enabled statisticians to estimate how the housing market functioned as a machine providing ever more collateral (as money printing drove up house prices) for break neck speed private money creation. At the time, not enough people took notice of this (Godley did, however), but it was estimated and it is consistent with Post-Keynesian ideas about money. Statisticians however ignored securitization for too long – securitization and the neglect of shadow banking made statisticians underestimate balance sheets of and therewith money creation by for instance Irish and Dutch banks) These statistics are, however, not consistent with for instance the ECB macro models, which (quote!) ‘abandon‘ the use of money. No financial crises or overgrown banks in these models…. ‘Prices’ (even the ‘price’ between present labour and future leisure) are relative barter exchange rates and money (and banks, and monetary taxes, and companies building cash registers and whatever) does not exist, neither as part of the stock of capital (deposits) or as a means of exchange. Or, if it exists it is used as a kind of ‘good’ with different uses (‘loanable funds‘) instead of something which is routinely created and destroyed as part of market transactions all the time, for instance by people using a credit card, when a mortgage loan is initiated or when companies sell ‘on credit’ (mind that selling on credit is legally binding and creates a monetary asset). The most fundamental critique of this ‘abandoning money’/’loanable funds’ idea of money might have been voiced by Fieke van der Lecq. In her thesis she states (my slightly interpretative summary) that monetary, by definition forward-looking, contracts not only often literally create money (case in point: mortgages) but that, in a market economy with fundamental uncertainty, historical time and a historical flow of intertwined transactions money is unavoidable as people try (sometimes in vain) to mitigate uncertainty by using these forward-looking monetary contracts. Mind that ‘tenure’ and even an implicit, informal ‘day labour’ contract are forward-looking monetary contracts, too. We’re stumbling forward in a dense fog and create a tangled maze of monetary contracts which enables but also constrains our actions and where the ability to create additional credit is often crucial for our plans, be it the plan to buy a candy bar with a credit card or the idea obtain a dream house. When no credit options available, owning credit tokens created by others might do – no matter if these are Euro’s or Pounds.
About the measurement: statisticians measure the total amount of deposit money (i.e. bank money) as well as chartal money but state that only part of the amount of deposit money is used for transaction purposes (M3-money). Money stacked away in longer term saving accounts is ‘bean-counted’ but not classified as M3-money. In the present day low-interest environment this distinction becomes increasingly blurred, while in countries like Greece there clearly is a ‘flight into liquidity’, i.e. from longer term accounts to cash. This criticism also holds for Divisia money, the neoclassical answer to the statisticians. Divisia money ignores the balance sheet approach (but accepts the results of the estimates) and gives different weights to different kinds of M3 money, which on one hand makes sense as not all constituent parts of M3 have the same velocity. In a zero lower bound situation with very low interest rates all across the board these weights will have to be recalculated – but we do not have the historical data to do this. A more fundamental critique: using these weights destroys the accounting relationship between money and credit and therewith makes us loose track of credit risk connected to money creation. Neoclassical economists seem to hate balance sheets, in my opinion because these show that economic entities are intertwinted to the core – via money creation. See this Koo article which shows that the increase the amount of money in the USA during the recovery phase of the Great Depression was caused not by private but by the government borrowing from money creating banks… When economists neglect the obvious – they always do this for a reason. Divisia and M3 money can however be used next to each other!