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Wednesday, November 15, 2017

How Not To Defend DSGE Macro

I used to be quite animated in my dislike for Dynamic Stochastic General Equilibrium (DSGE) models, but my attitude has shifted: I have declared victory and gone home. At present, I only have a somewhat disinterested academic pursuit on one topic: are DSGE models actually mathematical models? Whether or not that is the case does not really affect the question of whether they are useful. The recent attempt at a defence by Christiano, Eichenbaum, and Trabandt confirmed my attitude; it was such a spectacular intellectual failure that it is not worth taking seriously.

Noah Smith has done an impressive smackdown on the paper on his website here. Noah Smith is probably one of the most sympathetic backers of mainstream macro outside of academia, and even he thought this attempt at defending DSGE macro was ridiculous (the "cackling cartoon villain" defense of DSGE).

If we rephrased the arguments of Christiano, Eichenbaum, and Trabandt, they are perhaps reasonable. One could argue that we need to use a modelling strategy similar to the one used by DSGE modellers to account for:

  1.  a shifting policy environment; 
  2. and to take into account macro relationships between all variables.

The first point is a lot more straightforward than economic arguments would suggest. For example, we cannot blindly rely on some regression model that is fit to data in one economic regime, and then extrapolate those results to a new institutional environment. Although this was allegedly the big insight of the forefathers of DSGE macro, it is an obvious point that I believe that most Keynesian economists were aware of. Keynes was not exactly a cheerleader for the early econometric work.

The second point -- that we need to take into account all macro relationships, and not reason from a partial analysis -- is the defining characteristic of macroeconomics. Keynes' discussion of effects such as the fallacy of composition are what drove the creation of a sub-discipline of macroeconomics in the first place.

Although those are reasonable points, it does not mean that DSGE macro actually fulfils those objectives. (One could easily raise doubts about other methodologies, including my preferred stock-flow consistent models.) I cannot hope to settle debates on those lines here.

However, the paper by Christiano, Eichenbaum, and Trabandt went completely off the rails when compared to that reasonable line of argument. In the abstract, we read:
One strategy is to perform experiments on actual economies. Unfortunately, this strategy is not available to social scientists. The only  [emphasis in original - BR] place that we can do experiments is in dynamic stochastic general equilibrium (DSGE) models.
They literally argue that no other economic modelling methodology even exists.

I would note that other DSGE researchers were somewhat horrified by the abstract as well. However, it finally explicitly raises a point that was always implicit in the DSGE literature: do they acknowledge the existence of other research programmes? In practice, the answer was they did not do so, which is exactly what the abstract suggests they should do.

As an outsider, one can only revise down one's opinion of the academic standards of mainstream economists. We have an intellectual debate in which one side refuses to admit the existence of the debate in the first place. I am not an expert on the scientific method, but it seems to me that is not how it is supposed to work.

(c) Brian Romanchuk 2017


  1. "One strategy is to perform experiments on actual economies. Unfortunately, this strategy is not available to social scientists. "

    Yes they do. Virtual economies. They appear with every trading game created. The more complex and sophisticated they are and the more people are involved in them, the more analogues can be drawn - particularly against dollarised areas.

    The paper is a statement of religious position. There is only one true God. Time to ignore them and concentrate our efforts upon creating tools with which we can explain reality to ordinary people. Let's cordon off the Ivory towers as we have Fukushima and keep the toxic waste inside.

  2. Since I think DSGE models are useless in practice, I do not spend any time reporting on whatever the latest alleged insight they give. However, as an ex-academic in real academic field, I believe one has a duty to acknowledge the other side in debates. And since central bankers are generally mainstream economists, and they control the policy rate I write about alot, I obviously need to take their views into account.

    In this case, the paper could probably be used as evidence in a charge of clinical insanity. Not all of my readers necessarily agree with my views, but this paper provides a wonderful example of what I dislike about DSGE macro. Furthermore, the problem is easily understood without needing to plow through any economist technical argle-bargle. When the obituary of DSGE macro is written, it will almost certainly be referenced.

  3. IMO it's not even just DSGE, does the overall academic economics field (mainstream) even want to be practical? The field is certainly large enough to be inward-looking and uses enough mathematical formalism to fool outsiders.


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