Home > Uncategorized > DSGE — a scientific illusion

DSGE — a scientific illusion

from Lars Syll

Dynamic stochastic general equilibrium (DSGE) models remain the work-horse models employed by many academics and research departments at central banks … Prior to the Global Financial Crisis the financial sector played no role in these DSGE models. That limitation is now widely acknowledged and numerous aspects of the financial sector have been incorporated into second and later generation DSGE models … Unfortunately, these efforts are misguided because they do not address the fundamental flaw in the microeconomic foundations of these models and this mistake is widely repeated in all later generations of DSGE models.

macroeconomics-14-638Many theorists today simply fail to recognize the limitations inherent in starting with the wrong microeconomic foundations; frictionless or perfect barter microeconomic foundations. Consequently, those theorists are now intent on introducing ‘monetary’, ‘financial’ and other ‘frictions’ without acknowledging that those ‘frictions’ are inconsistent with the perfect barter or frictionless microeconomic foundations of their models as well as long established principles of monetary theory …  

The misuse of the Walrasian or Arrow-Debreu GE microeconomic foundations, an imaginary world of perfect barter, largely explains why DSGE models proved so inept at understanding or anticipating the GFC and why attempts to now incorporate realistic and relevant features of the financial sector into such models also fail. In these DSGE models, money and the financial sector are converted into a friction and words and economic concepts take on different meanings.

Colin Rogers

If nothing else, the monumental failings and flaws of DSGE models — with or without inessential ‘frictions’ or other amendments — certainly shows the importance of model validation and checking the robustness and realism of assumptions and specifications. Describing modern economies ‘as-if’ consisting of ‘representative’ agents in the guise of self​-employed capitalists in a perfect barter economy is absurd and ultimately bound to fail. DSGE models are simply — from both empirical and methodological points of view — not suited for understanding modern monetary economies.

  1. Frank Salter
    November 28, 2018 at 10:22 am

    I would suggest a different title: DSGE, a non-scientific chimera.

    • Edward K ross
      November 28, 2018 at 7:47 pm

      I would add that lacks truth. Ted

  2. November 28, 2018 at 6:46 pm

    This DSGE nonsense is like a group of highly trained engineers standing around a junkyard developing ever-more-sophisticated models to predict which of the rusted hulks would theoretically go the fastest. In fact, none of the cars will ever run again. In fact, capitalism will never satisfy the needs and desires of everybody. It will continue to create artificial shortages of things people need to survive, ensure that only those with money get enough, and increase inequality of wealth and income. That’s what it does. We need a new paradigm for economics, one based on the idea that the purpose of the economy is to provide everybody with what they need to live dignified and productive lives. The approach called Five Elements Economics provides a foundation for such a paradigm.

  3. Helen Sakho
    November 29, 2018 at 12:39 am

    And I would add a new title, if I may: GIGO!

  4. Helen Sakho
    November 29, 2018 at 2:18 am

    In case I cause more needless confusion, GIGO = Garbage In, Garbage Out.
    I will stand corrected dear colleagues, but so far that does seem to be the mother of all assumptions and outcomes.

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