Comment on "Axel in Wonderland:DSGE

Economic Modelling, 2014

Modern DSGE models are microfounded and have deep parameters that should be invariant to changes in economic policy, so in principle they are not subject to the Lucas critique. But the literature has already established that misspecification issues also cause parameter instability after policy changes in DSGE models. This paper will look at the implications of parameter shifts for econometric policy evaluation, to see whether policy advice derived from DSGE models would have differed fundamentally from that which the policymakers of the 1970s derived from their reduced-form Phillips curves. The results show drift in most parameters, including those that are supposedly structural (such as the share of capital in production, habits or the elasticity of labor supply to the real wage), and major shifts in the impulse response functions derived from the real-time estimation of the model. After the expansionary monetary shocks of the early 1970s, a standard DSGE model would have behaved very similarly to an old-style Phillips curve, with marked shifts in parameter values and impulse response functions.

Economics : the Open-Access, Open-Assessment e-Journal, 2009

Over the past 15 years there has been remarkable progress in the specification and estimation of dynamic stochastic general equilibrium (DSGE) models. Central banks in developed and emerging market economies have become increasingly interested in their usefulness for policy analysis and forecasting. This paper reviews some issues and challenges surrounding the use of these models at central banks. It recognises that they offer coherent frameworks for structuring policy discussions. Nonetheless, they are not ready to accomplish all that is being asked of them. First, they still need to incorporate relevant transmission mechanisms or sectors of the economy; second, issues remain on how to empirically validate them; and finally, challenges remain on how to effectively communicate their features and implications to policy makers and to the public. Overall, at their current stage DSGE models have important limitations. How much of a problem this is will depend on their specific use at central banks.

2008

Over the past 15 years there has been remarkable progress in the specification and estimation of dynamic stochastic general equilibrium (DSGE) models. Central banks in developed and emerging market economies have become increasingly interested in their usefulness for policy analysis and forecasting. This paper reviews some issues and challenges surrounding the use of these models at central banks. It recognises that they offer coherent frameworks for structuring policy discussions. Nonetheless, they are not ready to accomplish all that is being asked of them. First, they still need to incorporate relevant transmission mechanisms or sectors of the economy; second, issues remain on how to empirically validate them; and finally, challenges remain on how to effectively communicate their features and implications to policy makers and to the public. Overall, at their current stage DSGEmodels have important limitations. How much of a problem this is will depend on their specific use at cen...

Journal of Economic Literature, 2018

for useful comments and discussion; and to Steven Durlauf, Yannis Ioannides, and Robert Solow for detailed suggestions. I retain responsibility for all errors of omission and commission. My views are not necessarily endorsed by the Federal Reserve System. † Go to https://doi.org/10.1257/jel.20181439 to visit the article page and view author disclosure statement(s). Azariadis: A Review Essay on A History of Macroeconomics from Keynes to Lucas authoritative, much like the Michelin Red Guide to Paris. 2.2 The Ebb and Flow of Ideas Keynes and Lucas are the leading figures in De Vroey's historical account, with Keynes commanding the first thirty years of macroeconomics, roughly 1940-70, Lucas commanding for the next thirty, and an uneasy balance between Keynesians and Lucasians marking the most recent twenty years. This battle of ideas is dotted by transformational events, or "breaches," as De Vroey chooses to call them. Breach one was Keynes himself, together with some early proponents of Keynesian macroeconomics like Hicks (1937), Modigliani (1944), and Klein (1950). Ideas by Friedman (1968) and Phelps (1968) on the natural rate of unemployment mark breach two, while breach three is a long-lasting attempt by Patinkin (1956), Clower (1965), Leijonhufvud (1968), Barro and Grossman (1971), Benassy (1975), Dreze (1975), and Malinvaud (1977) to lift the Manhallian macroeconomics of Keynes to the technical level of Walrasian general equilibrium through quantity rather than price adjustments. The novel concept was "disequilibrium," which clears markets by rationing the long side of each one when prices or wages are rigid or predetermined; the goal was to find how rationing in goods or factor markets depended on exogenous selections of prices and wages. Breach four was DSGE, a radical departure from Keynes, led by Lucas (1972) who emphasized market clearing and rational expectations. Sargent (1976) and Barro (1977) were important early contributors in this endeavor to remake macroeconomics on classical or Walrasian microfoundations. De Vroey identifies as breach five a number of related ideas in the 1970s and 1980s that focus on imperfections in factor markets arising from incompleteness or private information. The end results of these frictions were labor contracts, efficiency wages, and credit rationing. Important contributors include Fischer (1977), Taylor (1980), and Stiglitz and Weiss (1981). Before frictions in factor markets had time to grow roots in the literature, they were swamped by the next wave of ideas, the RBC model of Kydland and Prescott (1982). Breach six was in effect the second coming of DSGE, now cast in the language of the Cass-Koopmans model of optimal economic growth. Augmented by persistent shocks to the aggregate production function, the Cass-Koopmans model underwent fluctuations in national income, and in its main components, which looked like postwar business cycles. On the minus side, RBC models provide no guide for economic policy because all fluctuations are socially optimal, particularly so for monetary policy, which has no place in the optimum growth model. Central bankers were understandably concerned about this feature and highly receptive to the last breach on De Vroey's list, breach seven. This one occurs mainly in the late 1990s and marks a partial return to Keynesian ideas and models like the investment-saving (IS) schedule and the Phillips curve. Among the protagonists of this reversal are Calvo (1983), Taylor (1993), Galí (1999), Rotemberg and Woodford (1997), and Christiano, Eichenbaum, and Evans (2005). 2.3 The Economics of Keynes De Vroey takes great pains to distill Keynes's research program without much help from the General Theory. His final list comes down to three items: (i) Splitting unemployment into frictional or "normal" and involuntary or "abnormal," the latter being a symptom of labor rationing and a byproduct of insufficient aggregate spending. (ii) Understanding the role of increased uncertainty (lack of reliable "news")

2010

We propose a monetary model in which the unemployed satisfy the official U.S. definition of unemployment: people without jobs who are (1) currently making concrete efforts to find work and (2) willing and able to work. In addition, our model has the property that people searching for jobs are better off if they find a job than if they do not (that is, unemployment is involuntary). We integrate our model of involuntary unemployment into the simple new Keynesian framework with no capital and use the resulting model to discuss the concept of the nonaccelerating inflation rate of unemployment. We then integrate the model into a medium-sized DSGE model with capital and show that the resulting model does as well as existing models at accounting for the response of standard macroeconomic variables to monetary policy shocks and two technology shocks. In addition, the model does well at accounting for the response of the labor force and unemployment rate to the three shocks.

Journal of Economic Dynamics and Control, 2008

t ; e t Þa0 is plausibly a sign of model mis-specification. Requiring orthogonality between y à t and e t or between y t and e t , however, is not enough for identification. We also need identifying assumptions on e t .

2013

The global financial crisis has sparked renewed debate over the state of macroeconomic modeling, particularly in the lead up to the 2008/2009 Great Recession. The standard workhorse of macroeconomic modeling, the Dynamic Stochastic General Equilibrium (DSGE) model, has been subject to intensive scrutiny. Over the past decade, there has been significant increase in the use of DSGE models by central banks for policy analysis, forecasting and prescriptions. The majority of central banks from developed countries have established DSGE models, including the Federal Reserve Bank, the European Central Bank, the IMF and the Bank of England. Given their prevalence among central banks coupled with their use by policy makers for analysis and forecasting, the objective of this research paper is to assess the behavior and forecasts made by these DSGE models in the run up to a financial crisis. A DSGE model is estimated for the United States for the pre-crisis period Q1.1947 to Q4.2007. An empirical verification of the data is undertaken, whereby forecasts made by the DSGE models are compared with the observed post-crisis data. We find that the DSGE model does a poor job of forecasting the Great Recession, and gives no indication that a downturn is imminent in the economy. Within the current paradigm, there is no role for financial frictions. As such, we suggest that the building blocks of DSGE models are too simplistic to effectively model key dynamics within the economy. We use the role of debt accumulation by US households as a means of illustrating this. Section 1: Introduction The global financial crisis has sparked renewed debate over the state of macroeconomic modeling, particularly in the lead up to the 2008/2009 Great Recession. Beginning as a crisis of debt and asset price inflation, the 08/09 crisis lead to the simultaneous decline of almost every asset category-leaving investors with nowhere to hide. Global per capita output saw the biggest contraction the world had experienced since WWII. What is perhaps even more significant is that the mainstream macroeconomic models adopted by the most influential central banks across the world, seemed pretty inept at forecasting such a crisis. The standard workhorse of macroeconomic modeling, the Dynamic Stochastic General Equilibrium (DSGE) model in particular, has been subject to intense scrutiny. DSGE models represent a broad class of macroeconomic model which combines elements of the standard neoclassical growth model of King, Plosser, and Rebelo (1988), the Real Business Cycle theory of Kydland and Prescott (1982), with the introduction of real and nominal frictions within a New Keynesian framework, as popularized by Christiano, Eichenbaum, and Evans (2005), and Smets and Wouters (2003, 2007). These real and nominal frictions can take the form of sticky prices and wages, habit formation in the consumption equation and adjustment costs in the investment equations and are included in an attempt to capture real aspects of the data, Harrison, and Oomen (2010). DSGE models are built upon microeconomic foundations, whereby the decision rules of economic agents are derived with respect to their preferences, technologies, and the current monetary policy regime, by solving intertemporal optimization problems. Exogenous stochastic shock processes are present in the model which cause shifts in, for example, the nominal interest rate set by the Central Bank, or total factor productivity. As a result, the decision rules of economic agents are subject to uncertainty. The DSGE model can be evaluated using several different methods, from calibrating the model, as in Kydland and Prescott (1982), to GMM estimation of equilibrium relationships, as in Christiano and Eichenbaum (1992), to the more popular Bayesian estimation techniques of for example, Christiano,

International Journal of Entrepreneurial Knowledge, 2014

DSGE are for a time the favorite models in the simulation of monetary policies at the central banks. Two of its basic assumptions are discussed in this paper: (a) the absence of endogenous nonlinearities and the exogenous nature of shocks and (b) the persistence of or the return to equilibrium after a shock, or the absence of dynamics. Our analysis of complex financial markets, using historical data of S&P500, suggests otherwise that financial regimes endogenously change and that equilibrium is an artifact.

Journal of Economic Dynamics and Control, 2013

Croatian Economic Survey, 2016