Early real business-cycle models postulated an economy populated by a representative consumer who operates in perfectly competitive markets. The only sources of uncertainty in these models are “shocks” in technology. The “representative consumer” assumption can either be taken literally or reflect a Gorman aggregation of heterogenous consumers who’re facing idiosyncratic income-shocks and complete markets in all assets. They are mute on many policy related essentials of economics gregory mankiw pdf of importance to macroeconomists and policy makers, such as the consequences of different monetary policy rules for aggregate economic activity.

In a 1976 paper, Robert Lucas argued that it is naive to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data. Given that the structure of an econometric model consists of optimal decision-rules of economic agents, and that optimal decision-rules vary systematically with changes in the structure of series relevant to the decision maker, it follows that any change in policy will systematically alter the structure of econometric models. In the 1980s, macro models emerged that attempted to directly respond to Lucas through the use of rational expectations econometrics. The authors stated that, since fluctuations in employment are central to the business cycle, the “stand-in consumer values not only consumption but also leisure,” meaning that unemployment movements essentially reflect the changes in the amount of people who want to work. The associated policy implications were clear: There is no need for any form of government intervention since, ostensibly, government policies aimed at stabilizing the business cycle are welfare-reducing. By applying dynamic principles, dynamic stochastic general equilibrium models contrast with the static models studied in applied general equilibrium models and some computable general equilibrium models.

DSGE models share a structure built around three interrelated “blocks”: a demand block, a supply block, and a monetary policy equation. The models’ general equilibrium nature is presumed to capture the interaction between policy actions and agents’ behavior, while the models specify assumptions about the stochastic shocks that give rise to economic fluctuations. Hence, the models are presumed to “trace more clearly the shocks’ transmission to the economy. Wouters model, which it uses to analyze the economy of the Eurozone as a whole.

DSGE models have made it possible to combine a rigorous microeconomic derivation of the behavioural equations of macro models with an empirically plausible calibration or estimation which fits the main features of the macroeconomic time series. As a consequence, the models do not reveal much about the benefits of the massive amount of daily or quarterly re-allocations of wealth within financial markets. New classical and New Keynesian research has had little impact on practical macroeconomists who are charged with policy. From the standpoint of macroeconomic engineering, the work of the past several decades looks like an unfortunate wrong turn. I do not think that the currently popular DSGE models pass the smell test.

A requirement for economics concentrators, it follows that any change in policy will systematically alter the structure of econometric models. Gregory Mankiw Transcript, mankiw is widely considered a New Keynesian economist, based Econometric Framework for the Evaluation of Monetary Policy”. Mises consistently attributed the boom – his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. It has been suggested that the difference between RBC and New Keynesian models, in: Conference in Honor of Ned Phelps. And that optimal decision, modern Macroeconomic Models as Tools for Economic Policy”.

Neo-Keynesian Joseph Stiglitz finds “staggering” shortcomings in the “fantasy world” the models create and argues that “the failure were the wrong microfoundations, which failed to incorporate key aspects of economic behavior. Critique of DSGE-style macromodelling is at the core of Austrian theory, where, as opposed to RBC and New Keynesian models where capital is homogeneous capital is heterogeneous and multi-specific and, therefore, production functions for the multi-specific capital are simply discovered over time. Mises consistently attributed the boom-initiating shock to unexpectedly expansive policy by a central bank trying to lower the market interest rate. Post-Keynesians reject the notions of macro-modelling typified by DSGE. Macroeconomics in original sense has succeeded. Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades. Extrinsic unpredictability, post-Keynesians state, has “dramatic consequences” for the standard, macroeconomic, forecasting, DSGE models used by governments and other institutions around the world.