New eBook: DSGE Models in the Conduct of Policy: Use as intended

Friday, April 28, 2017

Do Dynamic Stochastic General Equilibrium (DSGE) models perform a useful role in economic research? Some economists suggest not, due to their complex nature and disputable assumptions. The authors of this eBook argue that these models, which are used in many central banks, are part of a much wider policy process and cannot be seen in isolation. However, there is need better inclusion of key markets and frictions, and awareness of their limitations. This eBook provides an all-round evaluation of their current and historical uses; examines their challenges and opportunities; and evaluates their future in economics.

Joint editors of the eBook, Refet S. Gürkaynak and Cedric Tille say:

“The essence of any model is to offer a concise view of an aspect of the economy. DSGE models thus rely on simplifying assumptions, like all models, and are not meant to answer all questions. While some assumptions proved too restrictive, such as the lack of a financial sectors with inefficiencies, these are being addressed and do not justify abandoning the entire approach.

Models are one out of many inputs in the policy process. Their major advantage is to offer an internally consistent view of the economy, and serve as laboratory for “what if” scenario analyses. Policymakers should evaluate the message from models against a host of other indicators. And policymakers in this volume note they do precisely that. Researchers similarly understand the strengths and limitations of DSGE models, working to alleviate the deficiencies. It is gratifying to see research feeding into the policy process the way it should.”

Policy Lessons

  1. DSGE models have their place in the toolbox of policymakers. They are particularly useful as internally-consistent frameworks to contrast alternative policy scenarios.
  2. DSGE models of earlier vintages had clear limitations, but these can be - and are being -- addressed in richer versions.
  3. As with any model, DSGE should be used bearing in mind the underlying hypotheses and focus. Policymakers have found that relying on a series of complementary models is a much fruitful approach than trying to build the right model.
  4. Building, maintaining and extending DSGE models is resource intensive so their use in policymaking should be well thought through before investing in these models.

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