Home > Uncategorized > A short note on the production boundary of neoclassical macro models

A short note on the production boundary of neoclassical macro models

The neoclassical macro ‘DSGE’ models do not seem to have a rigorous model consistent ‘production boundary’.

A ‘prior’ in macro economics is the production boundary: what are we talking about? Famously, Adam Smith more or less excluded services – or at least services from personal servants. While the present national accounts  basically include everything which yields a monetary income, including illegal activities. The phrases ‘more or less’ and ‘basically’ of course indicate that delineating the boundary is not easy. Daniel Urban wrote a very clear piece about the classical boundary, the national accounts boundary, the neoclassical micro boundary (everything which yields ‘utility’, whatever that is) and the Marxian boundary (everything wich employs wage labour which produces surplus value which can be used to increase ‘capital’ or wealth of the owning class). But he does not discuss neoclassical macro models. I do not know about any serious discussion of the production boundary of these models.

Implicitly, the boundary seems to be quite narrow. Take the next phrase from a long paper by Jesus Fernandez-Villaverde, Juan Rubio-Ramirez and Frank Schorfheide  about how to solve neoclassical macro models: “Consumption is defined as Personal Consumption Expenditure on Services (PCESV) plus Personal Consumption Expenditure on nondurable goods”. One has to distill this essential information about the models from a footnote… Of course, one can argue that durable consumption goods are in fact an investment – but the whole 150+ pages piece only mentions ‘investment’ once, in the sense that the model could be enriched with ‘a non-negative investment constraint’. Which to me, also considering other models, means that durable consumer goods are excluded. And this is not the only thing excluded in most models. A list: 

Production/consumption which seems to be excluded in most models:

  • Consumption of durable consumption goods (cars!)
  • Public goods and services (roads! education!)
  • the financial sector and consumption of financial services (insurance! payment services!)
  • Houses and hence construction

All these activities are included in the national accounts and the Flow of Funds – what a regression these neoclassical models are! There are models which incorporate public goods and services, houses or a financial sectors (which de facto however excludes money creating banks and hence consists of insurance companies, saving banks and pension funds). The models of course often do include GDP but doing so necessitates, to keep the model consistent, coherent and rigorous,  inclusion of durable goods, houses, the financial sector and public goods and services.

Two points: this leaves one in fact with a sectoral model instead of a macro model. And, on a meta level, neoclassical macro economists shun discussions about this. They shouldn’t. They should, after all these decades, get together and finally agree about what they are actually talking about.

 

 

  1. Prof James Beckman, Germany
    May 18, 2018 at 10:10 am

    Important obsevation, indeed. Intuitively we see that with a given technology at one point in time & place, land can yield just so much output–subject to weather, strikes & herbicides coming from adjoining fields among other conditionals. Yet one only has to change the currency exchange rate to find that in cost/revenue terms the output changes. No one in the real world cares much about product quanty if pricing can maintain or increase the revenue flow. In other words a production frontier always yields to the revenue frontier. That’s why a few Swiss watchmakers will labor mightily to produce a few custom pieces at $250,000- $500,000 each from year to year. Of course, this then blends nicely into the pricing of luxury products.

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