by ‘New Keynesian’ DSGE models — unparalleled spectacular failures The problem of the DSGE-models (and more generally of rational expectations macroeconomic models) is that they assume extraordinary cognitive capabilities of individual agents … The fact that the assumption of rational expectations is implausible does not necessarily mean that models using such an assumption cannot be powerful tools in making empirical predictions. The problem, however, is that rational expectations macroeconomic model make systematically wrong predictions, in particular about the speed with which prices adjust. This empirical failure could have led the profession of macroeconomists to drop the model and to look for another one. Instead, macroeconomists decided to stick to
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‘New Keynesian’ DSGE models — unparalleled spectacular failures
The problem of the DSGE-models (and more generally of rational expectations macroeconomic models) is that they assume extraordinary cognitive capabilities of individual agents …
The fact that the assumption of rational expectations is implausible does not necessarily mean that models using such an assumption cannot be powerful tools in making empirical predictions. The problem, however, is that rational expectations macroeconomic model make systematically wrong predictions, in particular about the speed with which prices adjust. This empirical failure could have led the profession of macroeconomists to drop the model and to look for another one. Instead, macroeconomists decided to stick to the rational expectations model but to load it with a series of ad-hoc repairs that were motivated by a desire to improve its fit …
The success of the DSGE-model has much to do with the story it tells about how the macroeconomy functions. This is a story in which rationality of superbly informed and identical agents reigns … We have questioned this story … No individual can ever hope to understand and to process the full complexity of the world in which he lives. That’s why markets are so important. They are institutions that efficiently aggregate the diverse bits of information stored in individual brains …
De Grauwe’s critique of the repair shop treatment of DSGE modelling convincingly shows that ‘New Keynesian’ tweaking of DSGE models will not do the job. Why? Basically, they do not acknowledge genuine real-world uncertainty, and without this acknowledgement, the job will not be done appropriately.
It also underscores the necessity of being sceptical of the pretences and aspirations of ‘New Keynesian’ macroeconomics. So far it has been impossible to see that it has yielded very much in terms of realist and relevant economic knowledge. And — as if that wasn’t enough — there’s nothing new or Keynesian about it!
‘New Keynesianism’ doesn’t have its roots in Keynes. It has its intellectual roots in Paul Samuelson’s ill-founded ‘neoclassical synthesis’ project, whereby he thought he could save the ‘classical’ view of the market economy as a (long run) self-regulating market clearing equilibrium mechanism, by adding some (short run) frictions and rigidities in the form of sticky wages and prices.
But — putting a sticky-price lipstick on the ‘classical’ pig sure will not do. The ‘New Keynesian’ pig is still neither Keynesian nor new.
The rather one-sided emphasis on usefulness and its concomitant instrumentalist justification cannot hide that ‘New Keynesians’ cannot give supportive evidence for their considering it fruitful to analyze macroeconomic structures and events as the aggregated result of optimizing representative actors. After having analyzed some of its ontological and epistemological foundations, yours truly cannot but conclude that ‘New Keynesian’ macroeconomics — on the whole, and not only regarding its repaired DSGE models — has not delivered anything else than ‘as if’ unreal and irrelevant models.
The purported strength of New Classical and ‘New Keynesian’ macroeconomics is that they have firm anchorage in preference-based microeconomics, especially the decisions taken by inter-temporal utility maximizing ‘forward-looking’ individuals.
To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations — without ever presenting either ontological or epistemological justifications for this claim — has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if these economists want to resurrect the omniscient Walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world. A model of the world — as De Grauwe puts it — “that like, in the socialist models of the past, assumes an all-knowing individual, who can compute the optimal plans and set the optimal prices.”