Liberty Street — The New York Fed DSGE Model Forecast–July 2018

This post presents an update of the economic forecasts generated by the Federal Reserve Bank of New York’s dynamic stochastic general equilibrium (DSGE) model. We describe very briefly our forecast and its change since March 2018. As usual, we wish to remind our readers that the DSGE model forecast is not an official New York Fed forecast, but only an input to the Research staff’s overall forecasting process. For more information about the model and variables discussed here, see our DSGE model Q & A.

 FRBNY — Liberty Street Economics
The New York Fed DSGE Model Forecast–July 2018
Sushant Acharya, Michael Cai, Marco Del Negro, Abhi Gupta, and Pearl Li

Michael Emmett Brady — J M Keynes on the Enemies of Capitalism: The Internal, Endogenous Threat to the Macro Economy from Wall Street Stock Market Speculators and Rentiers

Abstract

J M Keynes carefully read Adam Smith’s The Wealth of Nations (1776) before he was 28. Of extreme importance to Keynes was Smith’s categorization of a group of upper income class citizens, whose speculative and financial interactions with the private banking industry created a very severe danger to the society as a whole, as being projectors, imprudent risk takers, and prodigals. Keynes’s description of Smith’s projectors, imprudent risk takers, and prodigals in the General Theory, as well as Keynes’s extremely important, early 1937 papers in the Eugenics Review and Quarterly Journal of Economics, is that Smith’s projectors, imprudent risk takers, and prodigals are Keynes’s Wall Street speculators and rentiers. It is the speculators and rentiers who are mainly responsible for the problems of inflation and deflation in the macro economy. Keynes realized that this destructive, casino-gambling type behavior that is so damaging to the macro economy is facilitated and financed by the “…forces of banking and finance”.

Keynes’s Chapter Twelve analysis on pages 147-162 in the General Theory of the speculative dangers resulting from the financial behavior of Wall Street speculators and rentiers is identical to Smith’s pages 114-115, 279-341 discussions in the Wealth of Nations of the dangers from projectors, imprudent risk takers, and prodigals.

Both Smith’s and Keynes’s analysis complements each other. Both Smith and Keynes could have given the exact, same, vastly superior analysis and policy advice to government officials facing the 2007-2009 Great Recession that would have been greatly superior to the type of very poor policy analysis provided by DSGE macroeconomists in the period 2006-2010.

Both Smith and Keynes explicitly point out and analyze the malign impacts(see Kennedy, 2008) on the macro economy perpetrated by either Smithian projectors, imprudent risk takers, or prodigals or Keynesian speculators and rentiers. The role of government is to impose constraints on these categories of upper income class members so as to prevent them from harming the sober people by proactive laws, rules, and regulations.

The obvious reason that DSGE macro models failed so egregiously is that there are no variables in their models representing the impacts of these types of decision makers on the macro economy over time. The reason for this misspecification modeling error by DSGE proponents is that they accept Bentham’s critique of Smith that there are no such individuals in the economy as Smith’s projectors, imprudent risk takers, or prodigals.

SSRN
J M Keynes on the Enemies of Capitalism: The Internal, Endogenous Threat to the Macro Economy from Wall Street Stock Market Speculators and Rentiers
Michael Emmett Brady, California State University, Dominguez Hills
Written: May 18, 2018

Brian Romanchuk — DSGE Wars (Again)

Although this sounds extremely harsh, it is the only way to describe aspects of DSGE macro such as the assumption that the level of interest rates is a key determinant of economic behaviour. In practice, this assumption is built into all mainstream models, and the empirical methodologies have no way of rejecting the assumption. It is not entirely an accident that the consensus has been shocked by the slow pace of recovery after modern recessions -- after all, it was believed that the level of interest rates was "unsustainably low." Indeed, the natural rate of interest had to be revised lower in order for the data to fit the theory.

In other words, the whole panoply of mathematics used is a gigantic red herring.

From the perspective of wanting to understand how the economy functions, there is only one real question: are the desired theoretical outcomes of DSGE macro practitioners useful? The fact that DSGE macro is roundly ignored by everyone whose job depends upon being right about the economy is probably the best answer to that question. (In theory, central bankers are supposed to care about being right about the economy, but in practice, even the raw incompetence displayed heading into 2007 did not cut into retired senior central bankers' subsequent speaking fees.)

From the perspective of academic economics, it is an obvious problem that this methodology has to be used in the "top journals." This is only a surprise if you assume that the academic system shows a tendency to progress towards the truth.…

Fitting the world to a model doesn't work so well.

The key criticsm from the POV of logical analysis and philosophy of science is this:

In Section 7.3, recursive competitive equilibrium is defined. It starts with a lot of mathematics, but even then, some economist hand-waving sneaks into the definition. They use terms that do not appear to correspond to standard mathematical concepts, and hope the reader knows what they mean. Mathematics largely consists of statements about sets and the property of sets; it is unclear what set properties they are describing at key sections of their definition.

Math may look impressive but it says nothing that is not contained in the stipulations — definitions and axioms that relate them. In represesntational models these stipulation establish the semantic connection with the "world" that the model purports to represent. That world provides the objective criteria for assessing the how representative a model actually is in application.

Problems at this foundational level result in GIGO. There is no room for lack of specificty in mathematical reasoning.

Bond Economics
DSGE Wars (Again)
Brian Romanchuk

Lars P. Syll — What is it that DSGE models — really — explain?

‘Rigorous’ and ‘precise’ DSGE models cannot be considered anything else than unsubstantiated conjectures as long as they aren’t supported by evidence from outside the theory or model. To my knowledge no in any way decisive empirical evidence has been presented.

No matter how precise and rigorous the analysis, and no matter how hard one tries to cast the argument in modern mathematical form, they do not push economic science forwards one single millimeter if they do not stand the acid test of relevance to the target. No matter how clear, precise, rigorous or certain the inferences delivered inside these models are, they do not say anything about real world economies.

Proving things ‘rigorously’ in DSGE models is at most a starting-point for doing an interesting and relevant economic analysis. Forgetting to supply export warrants to the real world makes the analysis an empty exercise in formalism without real scientific value.

Mainstream economists think there is a gain from the DSGE style of modeling in its capacity to offer some kind of structure around which to organise discussions. To me that sounds more like a religious theoretical-methodological dogma, where one paradigm rules in divine hegemony. That’s not progress. That’s the death of economics as a science.

Lars P. Syll’s Blog

What is it that DSGE models — really — explain?

Lars P. Syll | Professor, Malmo University

Bill Mitchell — Mainstream macroeconomics in a state of ‘intellectual regress’

At the heart of economic policy making, particularly central bank forecasting are so-called Dynamic Stochastic General Equilibrium (DSGE) models of the economy, which are a blight on the world and are the most evolved form of the nonsense that economics students are exposed to in their undergraduate studies. Paul Romer recently published an article on his blog (September 14, 2016) – The Trouble With Macroeconomics – which received a fair amount of attention in the media, given that it represented a rather scathing, and at times, personalised (he ‘names names’) attack on the mainstream of my profession. Paul Romer describes mainstream macroeconomics as being in a state of “intellectual regress” for “three decades” culminating in the latest fad of New Keynesian models where the DSGE framework present a chimera of authority. His attack on mainstream macroeconomics is worth considering and linking with other evidence that the dominant approach in macroeconomics is essentially a fraud.…

Bill Mitchell – billy blog
Mainstream macroeconomics in a state of ‘intellectual regress’
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Diane Coyle — Rescuing macroeconomics?

Short review of Roger Farmer's Prosperity for All: How To Prevent Financial Crises. 

Useful for those interested in DSGE.

The Enlightened Economist
Rescuing macroeconomics?
Diane Coyle | freelance economist and a former advisor to the UK Treasury. She is a member of the UK Competition Commission and is acting Chairman of the BBC Trust, the governing body of the British Broadcasting Corporation

Jason Smith — Keen, chaos, and equilibrium

Physicist Jason Smith critiques a debate among Steve Keen, Roger Farmer, Noah Smith, and David Andolfatto over Steve' recent Forbes post asserting that the economy is best modeled as a complex non-linear system instead of using the conventional linear stochastic models (DSGE) based on assuming general equilibrium.

Actually, as a physicist, I would say that even if the economy was a complex nonlinear chaotic system, linear stochastic models would still be its effective theory description. Regardless of what the quantum theory of gravity is, general relativity -- and even Newton's universal law of gravitation -- is still its long-distance effective theory.

Anyway, this prompted me to write something about Steve Keen's article in Forbes. Keen suffers from a problem that all public economists seem to suffer: asserting matters of opinion as matters of fact, and ongoing research programs as well-established frameworks. This will be made clear as we progress. Let's begin, shall we?

Information Transfer Economics
Keen, chaos, and equilibrium
Jason Smith

Brian Romanchuk — Macro Wars: Lavoie Article

Marc Lavoie has an excellent contribution to the recent reappearance of the "macro wars": "Rethinking Macroeconomic Theory Before the Next Crisis." I just want to note that he is possibly too academically reserved with regards to some of the claims justifying DSGE macro.…

Bond Economics
Macro Wars: Lavoie Article
Brian Romanchuk

Brian Romanchuk — Paul Romer's Criticisms of Mainstream Macro Are Weak

Although this paper has generated a fair amount of headlines, the criticisms are extremely weak from the perspective of mainstream economics, and there is no reason to expect it to cause changes in behaviour. Whatever debates it spawns will be a distraction from the deeper problems associated with DSGE macro.

Bond Economics
Paul Romer's Criticisms of Mainstream Macro Are Weak
Brian Romanchuk

Jason Smith — Macro is not like string theory, part III (Equations!)

I thought of another way to drive home the point that DSGE macro is not like string theory. It's essentially another way of representing the Venn diagram in that post, but this time in terms of equations. Basically, string theory is built up from a bunch of very successful pieces of physics in a natural way. A DSGE model is built of a bunch of pieces that haven't been empirically validated or worse appear to be wrong.…

Information Transfer Economics
Macro is not like string theory, part III (Equations!)
Jason Smith

Paul Romer — The Trouble with Macroeconomics

Paul Romer flushes DSGE.

SAGE
The Trouble with Macroeconomics
Paul Romer | Chief Economist, World Bank

ht Brad DeLong at Grasping Reality

Ramanan — DSGE, SFC And Behaviour

This is a continuation of my post Simon Wren-Lewis On Wynne Godley’s Models. I was comparing stock-flow coherent models to DSGE models implicitly (didn’t mention the ‘DSGE’).

The Case for Concerted Action
DSGE, SFC And Behaviour
V. Ramanan

Andrew Linton — On Loose definitions of Stock Flow Consistency

No DGSE models cannot be called Stock-Flow Consistent.

A correctly specified closed mathematical model will only have a ‘netting’ of flows to zero in one case – equilibrium. In that case you have all stocks no flows – but it cannot handle any out of equilibrium case of its time path – the real world. Because orthodox Neoclassical models are not defined in strict accounting terms – as a balance sheet of assets and liabilities that are unable to model consistency of relations that are defined as assets and liabilities, simple things like assets, debt and money. Crude attempts to overcome this – such as measuring in flows and outflows to a blobby body such as K the stock of capital have irresolvable issues of dimensionality through over over-aggregation.…

Decisions, Decisions, Decisions

On Loose definitions of Stock Flow Consistency

Andrew Linton

Lars P. Syll — Wren-Lewis on the New Classical Counter Revolution

Lars Syll marshals support in disagreeing with Simon Wren-Lewis.

Lars P. Syll’s Blog
Wren-Lewis on the New Classical Counter RevolutionLars P. Syll | Professor, Malmo University

Brian Romanchuk — DSGE Macro As An "All You Can Eat" Buffet (Part 1)

Brain states his position in the current debate on economic modeling.

The ongoing online debate regarding mainstream Dynamic Stochastic General Equilibrium (DSGE) models has again heated up. Professor Simon Wren-Lewis of Oxford discussed whether mainstream macro was eclectic; provoking a response from Professor Lars P. Syll of Malmö University, the latest of which is "'Deep Parameters' And Microfoundations". I am not interested in the entire spectrum of their debate, rather on the question of eclectic models. (This is the first part of a two-part series.)

Bond Economics
DSGE Macro As An "All You Can Eat" Buffet (Part 1)
Brian Romanchuk

Brian Romanchuk — The U.S. Business Cycle Viewed Through Multiple Model

Must-read if you are into economic modeling.

Bond Economics
The U.S. Business Cycle Viewed Through Multiple Models

Brian Romanchuk

Michalis Nikiforos — Not All Macro Models Failed to Predict the Crisis

Noah Smith has a post on the failure of macro theory to predict the crisis. He concedes that DSGE models did very badly on this score, but, he continues, “There are no other models out there that did forecast the crisis” and there is no better alternative.

The word “better” is important here because some “angry heterodox” people have pointed Smith to at least one alternative—Wynne Godley’s Seven Unsustainable Processes—that had in fact predicted the crisis.….

Multiplier Effect
Not All Macro Models Failed to Predict the Crisis
Michalis Nikiforos

Brad DeLong — Why the Hegemony of the New Keynesian Model?

Brad DeLong questions the reasoning behind the choice of DSGE modeling as the policy tool for central banks. Inquiring minds would like to know.

WCEG — The Equitablog
Why the Hegemony of the New Keynesian Model?Brad DeLong | Professor Economics, UCAL Berkeley

also

Important economic history lesson.

Project Syndicate
The Monetarist Mistake
Brad DeLong

The result was a host of policies based not on evidence, but on inadequately examined ideas. And we are still paying the price for that intellectual failure today.

Could ideological bias have had anything to do with it?

The dominance of Friedman’s ideas at the beginning of the Great Recession has less to do with the evidence supporting them than with the fact that the science of economics is all too often tainted by politics. In this case, the contamination was so bad that policymakers were unwilling to go beyond Friedman and apply Keynesian and Minskyite policies on a large enough scale to address the problems that the Great Recession presented.

Admitting that the monetarist cure was inadequate would have required mainstream economists to swim against the neoliberal currents of our age. It would have required acknowledging that the causes of the Great Depression ran much deeper than a technocratic failure to manage the money supply properly. And doing that would have been tantamount to admitting the merits of social democracy and recognizing that the failure of markets can sometimes be a greater danger than the inefficiency of governments.

The result was a host of policies based not on evidence, but on inadequately examined ideas. And we are still paying the price for that intellectual failure today.

Philip Mirowsi has documented how neoliberalism rose to power at this time, for example, in The Road from Mont Pelerin: The Making of the Neoliberal Thought Collective (2009) and has managed to stay in power in Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown (2013).

Matias Vernengo — Teaching macroeconomics: the resilience of the ISLM model

The interesting thing is that, although the ISLM is less used in theory, in particular because the multiplier story at the core of the IS has been substituted by a Ramsey intertemporal maximization story and the LM has been substituted by a Wicksellian interest rate rule, it is still the workhorse of macroeconomic teaching, and likely of simple policy thinking. In many ways the ISLM remains a much better basis for thinking about the economy than modern New Keynesian DSGE models (if nothing else because of the multiplier).

But is it still ISLM?

I don't have an issue with using gadgets to teach Econ 101 as long as they are presented as such. As far as using gadgets for policymaking, hmmm (thinks monetarism with a small m).

Naked Keynesianism
Teaching macroeconomics: the resilience of the ISLM model
Matias Vernengo | Associate Professor of Economics, Bucknell University

Lars P. Syll — Economic models — mistaking beauty for truth

Lars P. Syll’s Blog
Economic models — mistaking beauty for truthLars P. Syll | Professor, Malmo University