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It's a good point by Lars. The usual defence of DSGE models is that these assumptions do not matter; what policymakers need are quantitative predictions from the model. I.e., the hope is that you can fit a mathematical model to the observed data and use it to generate scenario outputs, even if the model assumptions look bizarre.
Unfortunately for the DSGE models, their poor specification of fiscal policy means that even the fitted models are of dubious use. The model fitting cannot compensate for the assumptions around the structure of fiscal policy.
The defense of the failure of DSGE modeling to predict the financial crisis was countered with the claim that subsequently it was shown how the assumptions could be tweaked to predict it. This was in hindsight after the fact. That's supposed to prove that "the model was capable of predicting the crisis"? Really?
The problem is that even after the tweaking the model to "predict" the crisis, the models will still not function properly in the period after the crisis. The models will tend to predict much faster growth than is realised
They may then be able to patch in some effect of "zero lower bound", (but that will not help in places like Canada where interest rates are still positive).
The continuous need for tweaks is the result of systematic errors in the fitting process. Even if the economy can be described by some simple mathematical model (which is somewhat questionable), their fitting procedure will estimate that hypothetical model incorrectly.
Also, those who are devoted to mathematical models at the expense of concern for justice remind me of this:
“But woe to you Pharisees! For you pay tithe of mint and rue and every kind of garden herb, and yet disregard justice and the love of God; but these are the things you should have done without neglecting the others. Woe to you Pharisees! For you love the chief seats in the synagogues and the respectful greetings in the market places. Woe to you! For you are like concealed tombs, and the people who walk over them are unaware of it.” Luke 11:42-44 New American Standard Bible (NASB)
4 comments:
It's a good point by Lars. The usual defence of DSGE models is that these assumptions do not matter; what policymakers need are quantitative predictions from the model. I.e., the hope is that you can fit a mathematical model to the observed data and use it to generate scenario outputs, even if the model assumptions look bizarre.
Unfortunately for the DSGE models, their poor specification of fiscal policy means that even the fitted models are of dubious use. The model fitting cannot compensate for the assumptions around the structure of fiscal policy.
The defense of the failure of DSGE modeling to predict the financial crisis was countered with the claim that subsequently it was shown how the assumptions could be tweaked to predict it. This was in hindsight after the fact. That's supposed to prove that "the model was capable of predicting the crisis"? Really?
The problem is that even after the tweaking the model to "predict" the crisis, the models will still not function properly in the period after the crisis. The models will tend to predict much faster growth than is realised
They may then be able to patch in some effect of "zero lower bound", (but that will not help in places like Canada where interest rates are still positive).
The continuous need for tweaks is the result of systematic errors in the fitting process. Even if the economy can be described by some simple mathematical model (which is somewhat questionable), their fitting procedure will estimate that hypothetical model incorrectly.
I'm reminded of epicycles.
Also, those who are devoted to mathematical models at the expense of concern for justice remind me of this:
“But woe to you Pharisees! For you pay tithe of mint and rue and every kind of garden herb, and yet disregard justice and the love of God; but these are the things you should have done without neglecting the others. Woe to you Pharisees! For you love the chief seats in the synagogues and the respectful greetings in the market places. Woe to you! For you are like concealed tombs, and the people who walk over them are unaware of it.” Luke 11:42-44 New American Standard Bible (NASB)
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